CERTIFIED EQUITY PROFESSIONAL INSTITUTE
ESPP
Employee Stock Purchase Plans
2015 EDITION
GPS
guidance | procedures | systems
Title Sponsors:
GPS
guidance | procedures | systems
Table of Contents
1.Introduction . . . . . . . . . 2
1.1.Overview.
1.2. Scope of Publication.
1.3. Public Comment.
2.Strategic Issues. . . . . . . 4
2.1.Overview.
2.2. Selecting the Appropriate
Plan.
2.3. Extending Plans to Non-US
Employees.
3.Plan Design . . . . . . . . . 7
3.1.Overview.
3.2. Design Features.
3.3. General Plan Requirements.
3.4. IRC §423 Requirements.
3.5. Nonqualified Plans.
3.6. Issues Related to Non-US
Employees.
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4.General
Administration . . . . 19
4.1.Overview.
4.2. Plan Details.
4.3. Stock Plan System
Functionality.
4.4.Outsourcing.
4.5. Issues Related to Non-US
Employees.
5.Plan Enrollment . . . . . 23
5.1.Overview.
5.2. Enrollment Process.
5.3. Post-Enrollment Activities.
5.4. Issues Related to Non-US
Employees.
6.Contributions
to the Plan. . . . . . . . 26
Certified Equity
Professional Institute
Santa Clara University
500 El Camino Real
Santa Clara, CA 95053-0400
[email protected]
www.scu.edu/business/cepi/
6.1.Overview.
6.2. Contribution Methods.
6.3. Changes in Contribution
Rates.
6.4. Testing Contribution Data.
6.5. Issues Related to Non-US
Employees.
7.The Purchase. . . . . . . .29
7.1.Overview.
7.2. Preparing for the
Purchase Date.
7.3. Calculating the Purchase.
7.4. Issuing Shares.
7.5. Post-Purchase Activities.
7.6. Issues Related to Non-US
Employees.
8.Tax Issues. . . . . . . . . . 34
8.1.Overview.
8.2. Employee Tax Consequences –
Nonqualified Plans.
8.3. Employee Tax Consequences –
Qualified Plans.
8.4. Employer Withholding and
Reporting Responsibilities.
8.5. Corporate Tax Deductions.
8.6. Issues Related to Non-US
Employees.
9.Legal. . . . . . . . . . . . . . 45
9.1.Overview.
9.2. Section 16 Reporting.
9.3. Blackout Periods.
9.4. Issues Related to Non-US
Employees.
10. Employee
Communication . . . 48
10.1.Overview.
10.2. Communication Strategies.
10.3. Ongoing Communications.
10.4. Communication Methods.
10.5. Issues Related to Non-US
Employees.
11. Financial Reporting. . 51
11.1.Overview.
11.2. Noncompensatory versus
Compensatory.
11.3. Grant Date and Requisite
Service Period.
11.4. Fair Value and Amortization
by Plan Feature.
11.5. Other Considerations.
11.6. Sensitivity of Valuation
Assumptions.
11.7. Share Limitations and the
Effect on the Valuation.
Appendices. . . . . . . . . . . 67
Exhibits
Exhibit 2-1:
Financial Impact of Plan Design Features
Exhibit 3-1:
Examples of Offering Periods
Exhibit 3-2: Qualified Plan with No Look-Back
Exhibit 3-3: Qualified Plan with Look-Back
Exhibit 3-4: Qualified Plan with Look-Back and Multiple Purchase Dates
Exhibit 3-5: Using a Beginning Price Limit
Exhibit 3-6: Limits on the Number of Shares Purchased Per Employee
Exhibit 3-7:
Advantages and Disadvantages of Restricting Sale of Shares
Exhbiit 3-8: Stock versus Tax Terminology
Exhibit 3-9: $25,000 Limitation for Qualified Plans
Exhibit 3-10: Carryover of $25,000 Limit
Exhibit 4-1:
Administration of an ESPP
Exhibit 4-2:Common Questions Regarding the Administrative
Functionality of Stock Plan Systems
Enrollment Process
Exhibit 6-1:
Contributions to the Plan
Exhibit 7-1:
Purchase Activities
Exhibit 8-1:
Wash Sale Rules
Exhibit 8-2: Tax Consequences to the Employee
Exhibit 8-3:Appreciating Market Value During Offering Period
and Gain on Disposition
Exhibit 8-4:Appreciating Market Value During Offering Period and
Loss on Disposition
Exhibit 8-5:Declining Market Value During Offering Period and
Gain on Disposition
Exhibit 8-6:Declining Market Value During Offering Period and
Loss on Disposition
Exhibit 8-7:
Employer Withholding and Reporting Responsibilities
Exhibit 8-8: Form 3922 Filing Requirements
Exhibit 10-1: Key Components of Communication
Exhibit 11-1: Value of ESPP Components
Exhibit 11-2: Summary of ESPP Plan Types
Exhibit 11-3: Type A Plan
Exhibit 11-4: Calculation of Fair Value of Type A and B Plans
ExhIbit 11-5: Qualified Plan with Look-Back
Exhibit 11-6: Qualified Plan with Look-Back and Multiple Purchase Dates
Exhibit 11-7: Valuation of Type C Plans
Exhibit 11-8: Valuation of Type D Plans
Exhibit 11-9: Modification Expense Related to Type D Plans
Exhibit 11-10:Valuation of Type G Plans
Exhibit 11-11: Impact of Dividends on the Valuation
Exhibit 11-12: Financial Reporting Impact of ESPP Features
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| Exhibits
Exhibit 5-1:
1.Introduction
1.1.Overview.
1.1.1. Employee stock purchase plans (ESPP) are an important component in a company’s total rewards structure. As fewer companies grant
stock options, restricted stock, or restricted stock units to all employees,
ESPPs provide a way for the company to offer a broad group of employees the opportunity to purchase discounted stock while minimizing the
financial statement impact.
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Each paragraph
in this publication
is numbered and
cross-referenced.
This document
should be used
in its entirety.
Readers of one
section will need
to reference other
sections for a
comprehensive
understanding.
1.1.2. An ESPP allows employees to purchase company stock, frequently
at a discount from fair market value (FMV). An employee chooses to
participate by enrolling in the plan and electing to have a percentage of
after-tax compensation deducted from each paycheck during an offering
period. During the offering period, the employer holds the funds deducted
from each paycheck. The purchase is facilitated by the company and the
employee pays no fees at the time of purchase. At the end of the offering
period, the funds are used to purchase company shares. The employee can
sell the shares or hold them. The specific provisions of ESPPs vary widely.
Some companies may provide a discount in the purchase price of the stock
at the purchase date or a look-back feature with a discount off the FMV of
the stock on the offering date or the purchase date (whichever is lower).
Many plans conform to the requirements of IRC §423, which allows the
participants’ shares to be eligible for preferential individual tax treatment,
and are therefore referred to as “qualified plans”.
1.2. Scope of Publication.
1.2.1. This publication focuses on the key concepts and challenges associated with employee stock purchase plans offered to US employees
by publicly traded companies headquartered in the US. The publication
addresses plans that qualify for special tax treatment under IRC Section
423 as well as nonqualified plans. Non-US employees frequently also participate in such plans. This publication highlights various non-US issues,
but is not intended to be a comprehensive review of the issues associated
with extending ESPPs to a global workforce. Except as otherwise noted,
this publication assumes US employees are US taxpayers and non-US
employees pay tax in other countries. Many countries also allow beneficial
tax treatment for ESPPs that would be tax-qualified under local tax laws.
Such qualified plans are outside the scope of this publication.
1.2.2. For purposes of this publication the following terminology will be used:
TERMINOLOGY
ESPP
Qualified and nonqualified employee stock purchase plans
Grant date
Tax term for offering date
Exercise of an option
Tax term for purchase date
Exercise price
Tax term for purchase price
Look-back
Plan design feature in which the purchase price of the shares is based on the lower of
FMV at beginning or end of the offering period
Nonqualified plans
Plans that are not qualified under IRC §423
Qualified plans
Plans that meet the criteria outlined in IRC §423; Does not include tax-qualified plans
that may be defined under local law in other countries
A more extensive glossary of terms can be found in Appendix B.
1.2.4. Previous publications specifically address issues of stock options, restricted stock/restricted stock
units, global stock plans, and performance awards. Much of the guidance in those publications is applicable
to ESPPs as well. For copies of those publications and information about future publications, visit
www.scu.edu/business/cepi/.
1.2.5. This publication was updated in 2015 to reflect the change in cost basis reporting for employers.
1.3. Public Comment.
1.3.1. The CEPI invited individuals and organizations to submit written comments on all matters related to
a draft version of this publication. All comments received were reviewed and incorporated as appropriate
into this final publication.
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1.2.3. ESPPs and associated processes can be varied and complex. This publication is not intended to cover
all possible variations. The processes described represent standard practice, but each company’s processes
may differ to reflect its unique needs and resources. These recommendations should be considered general
guidelines and applied as appropriate. Topics covered in this publication should be considered within the
particular facts and circumstances applicable to a company. For those reasons, clarifications such as “typically” and “generally” are not always included, but should be assumed. Please consult your own professional advisors with respect to the application of the information in this publication to company-specific
circumstances.
2. Strategic Issues
2.1.Overview.
2.1.1. ESPPs are frequently the only form of equity compensation offered
to a broad base of employees. To be an effective benefit for the employee and the company, the plan must balance the company’s objectives,
the employees’ benefit, administrative costs and challenges, as well as the
financial statement impact. Expectations regarding participation rates plus
the company’s growth plans should also factor into the decision-making.
Simplified plans are generally easier and less costly to administer. Automation will streamline administration, minimize errors, and reduce costs. Although the design of ESPPs may have significant variation, commerciallyavailable software will be of limited use in automating highly-customized
plans, and administrative costs will be significantly higher for these plans.
This section discusses the considerations when making strategic and tactical decisions.
2.2. Selecting the Appropriate Plan.
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strategic issues
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An ESPP must be
designed to meet
the company’s
objectives.
Additionally,
workforce
demographics
should be
considered
when designing
a plan. Weigh
the employee
benefit against
the company’s
financial and
administrative
costs.
2.2.1. An ESPP must be designed to meet the company’s objectives.
The company may want to increase employee motivation by providing a
qualified plan that provides a 15% discount with a look-back feature and
a 24-month offering period with interim purchases. Qualified plans are
used frequently to increase the tax effectiveness of the employee benefit.
The company may encourage employee loyalty by offering a nonqualified
plan with matching shares that vest one year after the purchase date of
the offering. For companies in which obtaining shareholder approval is
challenging, the plan may be designed with no look-back feature to manage share usage and make the plan more acceptable to shareholders. The
company may strive to enhance the employees’ sense of ownership by
increasing personal stock holdings. In this case, the company may design
a plan that includes post-purchase restrictions on selling the shares to encourage stock ownership. If the goal is to minimize the financial impact,
the plan may offer a 5% discount and no look-back feature. These design
features are discussed in more detail in Section 3, Plan Design.
2.2.2. Consider workforce demographics when designing a plan. The
ability of new hires to participate in the next offering of the plan may be
a critical advantage in attracting new employees. This feature may be
important to companies expanding their workforce. A less sophisticated
workforce with limited access to technology may be better served with a
simplified ESPP as opposed to a plan with complicated features. A quick
sale provision may increase participation in a newly designed ESPP. Companies should evaluate the interaction of stock price and average wages.
Some low-wage employees may be unable to contribute a sufficient
amount during an offering period to purchase a single share at the end
of the period. In this case, the plan may include a feature to roll forward
contributions representing a partial share to the next offering period. See
paragraph 2.3.1 to 2.3.3 for a more complete discussion of the considerations when extending ESPPs to non-US employees.
2.2.3. When designing a plan, weigh the employee benefit against the company’s financial and administrative costs. In most cases as the plan provides more benefit to the employee, the expense for financial reporting is higher. Exhibit 2-1 illustrates the financial statement impact of the following key design features:
• The length of the offering period
• Look-back or no look-back
• Discount on the purchase of a share of stock
EXHIBIT 2-1: FINANCIAL IMPACT OF PLAN DESIGN FEATURES
Assumptions:
• $10 stock price
• 50% volatility
• 0.25% risk-free interest rate
6 Months
12 Months
• 0% dividend yield
24 Months
No look-back, 5% discount
$0
$0
$0
Look-back, 5% discount
$1.90
$2.47
$3.26
No look-back, 15% discount
$1.49
$1.49
$1.48*
Look-back, 15% discount
$2.90
$3.47
$4.25*
* Slight variation on 24 months reflects the impact of a greater amount of interest foregone
over a longer period.
2.2.4. More complex design features like resets (discussed in subsection 11.4.11), rollovers (discussed in
subsection 11.4.12), and allowing for increases in contributions (discussed in subsections 11.4.13 to 11.4.15)
can increase the total expense associated with an offering. These features are triggered after an offering
period has started and the expense is not recorded until the event occurs. Such design features provide potential significant value to employees, but can be costly to administer, difficult for employees to understand,
and may significantly increase financial reporting expense and complexity. In many cases employees may
prefer a larger discount, which is more readily understood, to more complex design features, even though
the financial reporting impact may be comparable.
2.2.5. It is important to consider the impact of certain design features on employee participation. A noncompensatory plan, as discussed in paragraph 11.2.1, may seem attractive from an expense standpoint,
but is likely to have low participation rates, as employees may not see much value in this type of plan. At
the other end of the spectrum, a plan that contains rollovers and allows for increases in contributions may
have high employee participation, but the expense can be unpredictable. A plan with a 15% discount and a
look-back offers predictable expense patterns.
2.3. Extending Plans to Non-US Employees.
2.3.1. Many companies extend an ESPP to non-US employees. The non-US employees may have a different
perception of the benefits of participating in an ESPP and their participation rate may be lower than that
of US employees. Subsection 3.6 discusses the special design features to consider when extending an ESPP
to non-US employees. Subsection 3.4.3 discusses the specific benefits of a separate offering to achieve the
flexibility needed to meet the regulatory and tax requirements in other jurisdictions. The tax benefits of
participating in qualified plans are typically not available for non-US employees. See subsection 8.6 for a
discussion of the tax impact to non-US employees. The financial benefits also vary for non-US employees
because the risk of holding stock in a US company includes the risk of currency fluctuation (e.g., the rate of
conversion from US dollars to local currency will fluctuate) in addition to the risk of stock-price fluctuation.
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| strategic issues
A plan with no look-back and a 5% discount is considered noncompensatory (i.e., has no cost) for financial
reporting purposes. As expected, the financial cost increases for the other plans with a longer offering period, a look-back feature, or a larger discount. However, the cost of a plan with a look-back, a 5% discount,
and a six-month offering period ($1.90) is only slightly higher than cost of a plan with no look-back, a 15%
discount, and a 24-month offering period ($1.48). The financial cost of the plan design can be weighed
against the employee perception of the benefits of a look-back feature as compared to a 15% discount.
2.3.2. The administrative costs of extending plans to non-US employees may be significant. The local
payroll system may be unable to support payroll deductions for the ESPP (and in some countries deductions
may be prohibited). Tracking and plan administration may be decentralized at the local level or centralized.
Decentralized administration requires properly training personnel at the local level. Centralized administration may require extensive data transfers to and from the local entity.
2.3.3. In addition a variety of country-specific issues must be addressed, including:
• Securities, labor, insider trading, and exchange control filings and registration requirements
• Tax implications for employees and employers
• Currency conversion procedures
• Currency restrictions
• Requirements that employee contributions be held in a separate account or interest be
paid on the contributions
• Prohibitions or limitations on payroll deductions
• Labor law issues, such as approval by works councils, discrimination guidelines, or treatment
of the plan as a protected benefit
• Data privacy rules
• Translation requirements
• Acceptability of electronic acceptance and communications
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strategic issues
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The cost of offering an ESPP to non-US employees should be balanced against the benefit of participation
and the likely participation level. An ESPP need not be offered in all jurisdictions and, where appropriate,
employees in certain countries may be excluded from participation. See paragraph 3.4.2 for a discussion on
designating a parent or subsidiary to participate in the plan.
3. Plan Design
3.1.Overview.
3.1.1. An ESPP is a vehicle for employees to purchase company stock.
The design of a specific ESPP may vary depending upon the objectives
of the company. For example, a company may design a plan to encourage stock ownership, provide additional benefits to employees, and/
or increase retention. The plan should incorporate appropriate features
to achieve the company’s objectives. The common design features of
ESPPs are discussed in subsection 3.2 and examples of these features are
shown in Exhibit 3-2 to 3-4. Items that should be addressed in all plans
are discussed in subsection 3.3. The financial statement implications of
various design features are discussed in Section 11, Financial Reporting.
3.1.2. ESPPs are frequently designed to meet the requirements of IRC
§423 to provide tax benefits to US employees. The requirements of
qualified plans are discussed in subsection 3.4. The tax benefits of qualified plans are discussed in subsection 8.3. Nonqualified plans, which do
not meet the requirements of IRC §423, are discussed in subsection 8.2.
3.2. Design Features.
EXHIBIT 3-1: EXAMPLES OF OFFERING PERIODS
— 1/31/13
— 8/1/12
— 2/1/12
— 7/31/12
EXAMPLE 1: Offering period of six months with sequential offerings
P ▲
●
▲
P
●
— 1/31/16
— 7/31/15
— 1/31/15
— 7/31/14
— 1/31/14
— 7/31/13
— 1/31/13
— 7/31/12
— 2/1/12
EXAMPLE 2: Sequential offering period: 24 months w/purchases every six months
PPPPPPPP
▲
●
●
●
●▲
●
●
●
●
— 7/31/14
— 1/31/14
— 7/31/13
— 1/31/13
— 7/31/12
— 2/1/12
EXAMPLE 3: Overlapping offering period: 24 months w/purchases every six months
PPPP
▲
●
●
●
●
PPPP
▲
●
●
●
●
Key: Grant = ▲
P
Purchase = ●
Offering Period =
An ESPP is
typically a
broad-based plan
and all employees
are eligible to
participate. ESPPs
can be designed
to meet the
requirements
of IRC §423
to provide tax
benefits to US
employees, or
as nonqualified
plans.
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3.2.1. An ESPP allows employees to contribute funds during an offering
period. The offering period is the time over which the employee contributes to the plan. The offering period starts on predetermined dates
established by the Plan. The term of the offering period may be short
(e.g., one month) or long (e.g., two years). A purchase period is the
interval during the offering period when contributions are accumulated
for a stock purchase. At the end of the purchase period, stock is automatically purchased on the employee’s behalf. The offering period may
contain a single purchase period or multiple purchase periods. Offering
periods may be sequential or overlapping. See Exhibit 3-1 for examples
of offering periods. The most common offering is shown in Example 1.
3.2.2.An ESPP is typically a broad-based plan and all employees are eligible to participate. Plans may have
unique eligibility requirements. For example, a company may require a new hire to wait a prescribed period
before participating in the plan or seasonal/part-time employees working less than 10 hours a week may be
excluded from participation. Qualified plans must follow specific rules on who may or may not participate.
These rules are discussed in paragraph 3.4.4.
3.2.3. The purchase price is the price the employee pays for the stock and usually is at a discount to the
current FMV of the stock. A larger discount provides a greater benefit to the employee and typically results
in a larger expense for the company. In qualified plans the discount ranges from 0% to 15%, with 15%
most commonly used. Nonqualified plans may provide for discounts in excess of 15%. Some nonqualified
plans provide for matching shares in lieu of a discount. For example, an employee may purchase five shares;
the company would match one share, resulting in six shares to the employee.
3.2.4. The method of determining the FMV may be specified in the Plan (e.g., the price at market close on the
previous day or high/low average for the day). If the purchase date falls on a holiday or weekend, the Plan may
specify which date should be used (e.g., prior or next trading day). The FMV of shares purchased under an ESPP
may be determined differently than the FMV of other equity awards. The purchase price may also be defined
in the Plan as the lower of FMV at beginning or end of the offering period. This is commonly referred to as a
look-back. A look-back feature provides additional benefits to an employee when the stock appreciates during
the offering period. Exhibits 3-2 and 3-3 show examples of a qualified plan with and without a look-back. Exhibit
3-4 shows the impact of a look-back when combined with a longer offering period and multiple purchase dates.
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3.2.5. Upon enrollment the employee determines how much to contribute to the plan. Contributions can
be in any form, including payroll deductions and lump sum payments. A lump sum payment is a one-time
payment made in lieu of deducting contributions from an employee’s paycheck. Payroll deductions are most
common; but in some non-US jurisdictions, contributions through payroll deductions may be prohibited by
local law. The method used to collect employee contributions has no impact on financial reporting. Except as
otherwise noted, this publication will assume contributions are made through payroll deductions. The contribution rate is usually a percentage of income. Contributions are made on an after-tax basis. Employee contributions are typically limited for each employee by either a percentage of salary, a number of shares that may
be purchased, or a contribution dollar amount. Define the compensation components (such as base, overtime,
bonus, and commissions) to which the contribution rate applies. If variable compensation (e.g., overtime, bonuses, and commissions) is eligible compensation for the ESPP, include it in the initial share estimate to stabilize
the period expense, rather than adjusting for the impact of variable compensation at the time of purchase.
3.2.6. The Plan may allow employees to withdraw or increase/decrease the contribution rate during the offering
period. Providing the right to increase or decrease the contribution rate is at the discretion of the company; there
is no requirement to allow changes in the contribution rate for qualified plans. The Plan should specify when and
how often an employee may change his or her contribution rate. Usually a withdrawal from the plan is applicable
for the current offering period and the employee must re-enroll in the plan in order to participate in the future.
In some cases the employee may need to wait an extended period of time to reenroll. The Plan should define
when an employee may re-enroll and detail any restrictions on the enrollment. Employee terminations are usually
treated as withdrawals from the plan. Changes to the contribution rates require additional administration—the
Equity Compensation department must record the change and Payroll must process it. Contribution rate increases trigger modification accounting and will generate additional financial reporting expense. The benefit to the
employee of being allowed to change the contribution rate mid-offering should be balanced against the administrative burden and cost. Many companies allow no changes or only one change during an offering period. For
administrative convenience, prohibit changes within two weeks prior to the purchase date. Furthermore, consistent application of these features is important to ensure qualified plans continue to meet the equal rights and
privileges requirements (discussed in paragraph 3.4.4) and the plan does not become disqualified. See subsections 11.4.13 to 11.4.15 for a discussion of the financial reporting impact of changes to contribution rates.
3.2.7. On the purchase date employee contributions are used to purchase shares of stock at the designated purchase price. The company, at its discretion, may issue whole or fractional shares. Some stock plan
record-keeping systems, brokerage firms, or transfer agents do not support fractional shares. Illustration
Exhibit 3-2 assumes fractional shares are issued.
3.2.7.1.If only whole shares are issued, the number of shares purchased is rounded down and the
excess contribution, representing a fractional share, may be refunded to the employee or recorded as an
employee contribution for the next offering period. Refunds of excess contributions are typically processed through payroll.
3.2.7.2.Using fractional shares may maximize the benefit employees receive from the ESPP. In addition
fractional shares may simplify administration since excess contributions from rounding to whole shares
do not need to be refunded or tracked. Fractional shares are also advantageous if employee contributions are insufficient to purchase a whole share during an offering period. This is most appropriate for
non-US employees with a low wage base. On the other hand, employee confusion may arise with fractional shares, some brokerage firms do not support the sale of fractional shares, and additional complications can arise when shares are sold.
3.2.8. Choosing an appropriate offering period and purchase date helps minimize administrative challenges. The purchase date should not fall on days when the stock market is closed, during scheduled blackout
periods, at quarter end, or at year end. Vesting dates for other equity programs, especially restricted stock
or units, should be considered when setting the purchase date for the ESPP due to staffing considerations.
For example, if the annual restricted stock unit (RSU) grant vests on April 10, the ESPP purchase date should
not be April 10. Where possible, the purchase should occur in the middle of a pay cycle to allow sufficient
time to gather and reconcile contribution data before the purchase date.
EXHIBIT 3-2: QUALIFIED PLAN WITH NO LOOK-BACK
Plan Provisions:
Offering period
Offering price
Contribution
Inclusion of look-back
6 months
85% of fair market value on purchase date
$1,000 total (prorata amount deducted from each paycheck)
No
Assumptions:
Stock price at beginning of offering period (A)
Stock price at end of offering period (B)
Purchase price (C=85% of B)
Shares purchased (D=1,000 divided by C)
Shares purchased not limited by Plan
Fractional shares issued
Value from discounted offering price
Value from look-back
Total value delivered [(B - C) X D]
Flat
Stock Price
Appreciating
Stock Price
$10.00
$8.00
$6.80
147.0588
$10.00
$10.00
$8.50
117.6471
$10.00
$12.00
$10.20
98.0392
$176.47
$176.47
$176.47
$0.00
$0.00
$0.00
$176.47
$176.47
$176.47
EXHIBIT 3-3: QUALIFIED PLAN WITH LOOK-BACK
Plan Provisions:
Offering period
Offering price
Contribution
Inclusion of look-back
6 months
85% of fair market value on lower of FMV on grant date
or purchase date
$1,000 total (prorata amount deducted from each paycheck)
Yes
Depreciating
Stock Price
Assumptions:
Stock price at beginning of offering period (A)
Stock price at end of offering period (B)
Purchase price (C=85% of lesser of A or B)
Shares purchased (D=1,000 divided by C)
Shares purchased not limited by Plan
Fractional shares issued
Value from discounted offering price
Value from look-back
Total value delivered [(B - C) X D]
Flat
Stock Price
Appreciating
Stock Price
$10.00
$8.00
$6.80
147.0588
$10.00
$10.00
$8.50
117.6471
$10.00
$12.00
$8.50
117.6471
$176.47
$176.47
$176.47
$0.00
$0.00
$235.29
$176.47
$176.47
$411.76
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Depreciating
Stock Price
EXHIBIT 3-4: QUALIFIED PLAN WITH LOOK-BACK AND MULTIPLE PURCHASE DATES
Plan Provisions:
Offering period
Offering price
Contribution
Inclusion of look-back
24 months with purchases every 6 months
85% of fair market value on lower of FMV on
grant date or purchase date
$1,000 total (prorata amount deducted from
each paycheck)
Yes
Stock Price
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Assumptions:
FMV on February 1, 2012 (A)
FMV on July 31, 2012 (B)
FMV on January 31, 2013 (C)
$10.00
$8.00
$9.00
July 31, 2012 purchase
FMV on February 1, 2012 (A)
FMV on July 31, 2012 (B)
Lesser of 85% of lesser of A or B ($8.00 x 85%)
$10.00
$8.00
$6.80
January 31, 2013 purchase
FMV on February 1, 2012 (A)
FMV on January 31, 2013 (C)
Lesser of 85% of lesser of A or C ($9.00 x 85%)
$10.00
$9.00
$7.65
3.3. General Plan Requirements.
3.3.1. As with any equity plan, the formal plan document should incorporate broad language and function
as a conceptual framework. Administrative details (e.g., the use of fractional or whole shares) should be
subject to management approval and documented outside the plan. The Plan design should be flexible to
accommodate the unique needs of non-US employees, even though participation by non-US employees is
limited. For example, the Plan should allow the ESPP funds to be held in a separate bank account or interest
to be paid on ESPP contributions, as required in certain countries. This approach will allow companies flexibility to meet their changing business requirements without forcing them to secure additional shareholder
approvals for administrative changes to the plan.
3.3.2. Any changes to the plan or the administrative details supporting the plan must be communicated
internally and externally. Administrative processes and the stock plan record-keeping system may require
modification. Changes to the maximum contribution rates may require modification to the payroll system.
Vendor interfaces and processes may change. Notify employees of and educate them about changes that
will affect them. Consult legal counsel to determine if shareholder approval is required for changes to the
formal plan document.
3.3.3. All qualified plans are required to specify the maximum number of shares that may be issued under
the plan and the maximum number that may be issued per person and per offering. The maximum number
of shares that an employee may purchase can be a specific number of shares or a formula, provided the
maximum number of shares per employee can be determined at the offering begin date. The stated maximum that may be purchased by the employee does not have to be realistic. It can be set with the expectation that no employee will reach the limit. Including this limit is critical to establishing a grant date for tax
purposes. One technique for controlling share use is for the plan to specify a beginning price limit which
limits the number of shares that may be purchased based upon the price at the date of grant. A beginning
price limit will control share use when the stock price is volatile and a significant price drop may occur. See
Exhibit 3-5 for an example of a beginning price limit. See Exhibit 3-6 for an example of limiting the number
of shares purchased.
EXHIBIT 3-5: USING A BEGINNING PRICE LIMIT
Plan Provisions:
Offering period
Offering price
Contribution
Inclusion of look-back
Beginning price limit
6 months
Lower of FMV on grant date or purchase date
$10,000 total (prorata amount deducted from
each paycheck)
Yes
Yes
Assumptions:
FMV on grant date
FMV on purchase date
Maximum shares to be purchased
$10.00
$4.00
1,000 shares ($10,000/$10)
Price paid
($6,000 of excess contributions refunded to the employee)
$4,000 (1,000 x $4)
3.3.4. Predicting the number of shares that will be purchased can be challenging due to changes in contribution rates, compensation increases, purchase price, and number of participants. Safeguards should
be put in place to identify when the maximum number of shares will be reached. Develop processes for
dealing with insufficient shares. This is extremely important during periods of declining stock price for both
qualified and nonqualified plans. The most common method of dealing with share shortfalls is reducing the
shares purchased on a prorata basis.
Plan Provisions:
Offering period
Offering price
Contribution
Inclusion of look-back
Maximum purchased shares
6 months
85% of fair market value on purchase date
$10,000 total (prorata amount deducted from
each paycheck)
No
1,500 shares per offering period
Assumptions:
Stock price at beginning of offering period (A)
Stock price at end of offering period (B)
Purchase price (C=85% of B)
$10.00
$5.00
$4.25
Possible shares purchased (D=10,000 divided by C)
Maximum purchased shares (E)
2,352.94
1,500
Shares purchased (lesser of D or E)
Cost of shares (1,500 x $4.25)
1,500
$6,375
Refunded to employee ($10,000 – $6,375)
$3,625
3.3.5. A plan may contain a reset or a rollover feature that provides for a decrease in the purchase price if
the FMV of the stock declines during an offering period. (Note – Reset and rollover features are irrelevant
for plans with a single purchase in each offering period.) A reset means the look-back for future purchase is
calculated on the new reset price (typically the FMV the day after the reset is triggered) or the FMV on the
purchase date. This is analogous to an option repricing. A rollover will cause the remainder of the offering
period to be cancelled, and all employees will be rolled into a new offering period at the new lower price.
In the case of either a reset or a rollover, only future purchase periods are affected. The current period purchase is completed as usual and then the new price is reflected in future purchases. The financial reporting
impact is reflected on a prospective basis. The prevalence of reset and rollover features has diminished due
to the adverse accounting treatment.
3.3.6. Plans may restrict when employees can sell shares or transfer after the purchase. While such restrictions are not common, they are most frequently associated with qualified plans to ensure a two-year
holding period from date of grant and a one-year holding period from date of purchase to maximize the
employee tax benefits. Restricting the disposition of shares is at the discretion of the company and should
reflect the company’s objectives for the plan. For example, if the company’s objective is to encourage share
ownership, requiring employees to hold shares for a certain period after purchase achieves that objective.
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EXHIBIT 3-6: LIMITS ON THE NUMBER OF SHARES PURCHASED PER EMPLOYEE
Employees may perceive such restrictions negatively. The inability to sell the shares and access the sales
proceeds may reduce employee participation in the plan. This restriction may be particularly difficult for
employees enrolled in nonqualified plans and non-US employees since the difference between the FMV at
purchase and the purchase price is taxed at the purchase date. The taxable transaction may result in a financial hardship to the employee if the shares cannot be sold immediately to fund the required tax and the
required tax is withheld from the employee’s paycheck. In addition administering such restrictions can be
time consuming and require close coordination with a designated brokerage firm and/or third-party administrator. See Exhibit 3-7 for a summary of the advantages and disadvantage of restricting sale of shares.
EXHIBIT 3-7: ADVANTAGES AND DISADVANTAGES OF RESTRICTING SALE OF SHARES
Advantages
• Encourages share ownership
Disadvantages
• Maximizes tax benefits of qualified plans
• Limits employee flexibility to take advantage of market
fluctuations in the stock price
• Reduces administrative burden of tracking
dispositions for qualified plans
• May limit participation rates, especially for non-US
employees
• Taxable transaction for nonqualified plans or non-US
employees with no sales proceeds to fund the required
tax (i.e., tax may need to be withheld from payroll)
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3.3.7. Plans may include a provision that facilitates an immediate sale of shares purchased by an employee.
This is commonly referred to as a “quick sale” and is similar to a same-day-sale for the exercise of a stock
option. The employee may authorize the sale the shares when he or she enrolls in the plan, during the contribution period, or immediately before the purchase. A broker facilitates the sale of the shares purchased. A
quick sale will minimize the employee’s impact of the market fluctuation in the stock price and provide the
employee with cash. The company may facilitate the quick sale for non-US employees by distributing the
sales proceeds, net of any required tax withholding, through local payroll. Allowing quick sales may increase
participation in the plan. On the other hand such a provision discourages shares ownership and may be
contrary to the objectives of the Plan.
3.4. IRC §423 Requirements.
3.4.1. A plan is qualified and participants in it can receive preferential tax treatment if it meets the requirements of IRC §423. See Section 8, Tax Issues, for a discussion and examples of the tax consequences
to employees of purchasing and selling shares in a 423 plan. For tax purposes a 423 plan is considered a
statutory stock option plan. The option is “granted” at the beginning of the offering period and “exercised”
on the purchase date. See Exhibit 3-8 for a comparison of common terms for stock and tax purposes. This
publication will use the terminology of grant and exercise when describing the tax requirements associated
with 423 plans.
EXHBIIT 3-8: STOCK verses TAX TERMINOLOGY
Stock Terminology
Tax Terminology
Participant/employee
Optionee
Enroll in the plan
Participate in the plan
Offering date/offering begin date
Grant date
Offering period
Option period
Purchase period
Option period*
Purchase date
Exercise date
Purchase price
Exercise price
Look-back
Option price is the lesser of
• 85% of the FMV when the option is granted or
• 85% of the FMV when the option is exercised
* For example, for tax purposes a 24-month offering period with purchase periods every six months is considered
a series of options - See diagram on next page.
◆
▲
◆
▲
— 1/1/14
▲
— 7/1/13
— 7/1/12
◆
Key: Grant = ▲
— 1/1/13
— 1/1/12
▲
◆
Exercise = ◆ Offering Period =
3.4.3. IRC §423 permits separate consecutive or overlapping offerings for each entity or group of entities
within the corporate group. The separate offerings can include variations in terms among corporate entities during the same offering/purchase period. This can be particularly useful when dealing with non-US
employees. For example, one offering could permit contributions by payroll deductions for one entity and
another offering could permit lump sum payments. Each separate offering must meet the requirements
regarding employee coverage and equal rights and privileges, which are discussed in paragraph 3.4.4.
Separate offerings can be established for each entity or group of entities in the Plan and/or by Board or
Compensation Committee resolution. In either case, appropriate language must be included in the Plan to
permit separate offerings.
3.4.4. In addition a 423 plan must meet the following requirements:
• Employees only.
Only employees of the sponsoring corporation or its parent or designated subsidiaries can participate in
a 423 plan. IRC §423(a) provides a limited exception for employees who terminate within three months
before the purchase date. Such terminated employees may continue to participate in the Plan for the
remainder of the offering period; however, in practice most plans treat terminated employees as withdrawing from the Plan upon termination.
Separate Offerings
Separate offerings can be used to permit a variation in terms among corporate entities during
the same offering/purchase period. Each separate offering must meet the requirements of
IRC §423 regarding employee coverage and equal rights and privileges. Separate offerings
are frequently used for non-US employees to permit lump sum payments, provide different
participation for part-time employees, define country‑specific compensation components (e.g.,
thirteenth-month payments), and avoid risk of administrative failures that would disqualify
the entire offering.
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3.4.2. To qualify as a 423 plan, the written plan must specify the maximum number of shares that may
be issued under the plan and designate the corporations or class of corporations whose employees may be
offered options under the plan.1 The sponsoring corporation (i.e., the company that grants the option) may
designate the corporations that may participate in the plan. Any subsidiary in the corporate group that is at
least 50% owned may participate and any branch of a participating company will automatically participate.
The designated subsidiaries must also be treated as subsidiaries for US tax purposes and the sponsoring corporation must take into account whether the entity is subject to a “check-the-box” election to be disregarded and/or treated as a subsidiary. The sponsoring corporation can designate a subsidiary formed under US
law or non-US law. The rules regarding which entities may participate in a plan are complex and dependent
on the company’s corporate structure. Where appropriate, Corporate Tax should determine which corporate
entities may participate in the plan.
• Shareholder approval.
The plan must be approved by the shareholders of the sponsoring corporation within 12 months before
or after the date the plan is adopted. Most companies begin the first offering after the shareholders
have approved the plan. If shareholder approval has not been received prior to the first offering, the offering should be contingent upon the plan receiving shareholder approval to avoid tax complications.
• 5% owners excluded.
No employee can be granted an option under the plan if the employee, immediately after the option
grant, would own stock comprising 5% or more of the total voting power or value of all stock of the
sponsoring corporation or its parent or subsidiary.
• Nondiscriminatory.
Options must be granted to all employees of any corporation covered by the plan with the exception of:
• Employees who have been employed less than two years
• Employees whose customary employment is 20 hours or less per week
• Employees whose customary employment is not for more than five months in any calendar year
• Highly compensated employees as defined in IRC §414(q).
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Although corporations may exclude employees who have been employed less than two years, most
compnies permit new employees to participate in the plan during the next offering period. In addition
employees who are citizens or residents of a non-US jurisdiction may be excluded from the plan if the
grant under the plan is prohibited under local law or if compliance with local law would cause the plan
to violate the IRC §423 requirements. A separate offering for a specific subsidiary is permitted to accommodate requirements under local law. For example, German and UK employees working less than 20
hours a week could participate in the ESPP as required by the EU part-time employee coverage requirements, provided the specific German and UK subsidiaries employing these individuals are in a separate
offering. US employees working less than 20 hours a week would be excluded from participating in the
same plan provided they are in a separate offering in which part-timers are excluded.
• Equal rights and privileges.
All employees participating in an ESPP or offering must have the same rights and privileges. This requirement is not violated if the plan specifies that an employee may not contribute more than a maximum
percentage of compensation or limits the maximum dollar (or other currency) amount that can be
contributed or number of shares that can be purchased. For example, a plan that specifies an employee
can contribute up to 8% of compensation would not violate the equal rights and privileges requirement.
Less favorable terms may be offered to citizens or residents of a non-US jurisdiction if required under
local law without violating this requirement. If non-US employees require more favorable terms under
local law, such terms must be offered to all plan participants within the same offering. The carry forward
of excess contributions representing a fractional share, discussed in paragraph 3.2.7, does not violate the
equal right and privileges requirement. The carry forward of contributions in excess of a fractional share,
(i.e., where employee or offering limits have been reached) would be a violation of the equal rights and
privileges requirement unless all other employees within the same offering were permitted to make lump
sum payments of equal amounts.2
• Option price.
Under the terms of the plan, the purchase price must be at least 85% of the stock’s FMV on the date of
grant or exercise. The FMV of the stock can be determined in any reasonable manner such as the price at
market close or the high/low average on the grant date.
• Option period.
If the purchase price is based upon the lesser of the stock’s FMV on the date of grant or exercise, the
offering period cannot exceed 27 months. If the option price is at least 85% of the stock’s FMV on the
exercise date, regardless of the FMV on the grant date, the offering period cannot exceed five years.
The grant date is the first day of the offering period, provided the plan designates the maximum number
of shares that may be purchased by each employee during an offering period or a formula for determining the maximum number of shares each participant can purchase during an offering period.
Establishing the Grant Date
Establishing the grant date as the first day of the offering period is important because
the grant date –
• Serves as one of the dates on which the purchase price may be determined in a plan
with a look-back feature
• Is the start date for the two-year holding period for qualifying dispositions
• Determines the FMV used in calculating the $25,000 limit
To establish the grant date for tax purposes on the first day of the offering period, the plan
must designate the maximum number of shares that may be purchased by each employee
during the offering period or give a formula for determining the maximum number of shares
each participant can purchase. If these requirements are not met, the grant date is deemed to
occur on the purchase date.
Unless otherwise stated, this publication assumes that the grant date is established as the first
day of the offering period.
EXHIBIT 3-9: $25,000 LIMITATION FOR QUALIFIED PLANS
Assumptions:
Offering period
Offering price
FMV on grant date
FMV on purchase date
Purchase price
January 1 – December 31, 2012
85% of FMV on lower of FMV on grant date or purchase date
$10.00
$12.00
$ 8.50
An employee could purchase a maximum of 2,500 shares ($25,000 / $10 per share FMV on grant date)
on December 31, 2012.
EXHIBIT 3-10: CARRYOVER OF $25,000 LIMIT
Assumptions:
Offering period
Offering price
FMV on grant date
FMV on purchase date
Purchase price
September 1, 2012 – August 31, 2013
85% of FMV on lower of FMV on grant date or purchase date
$10.00
$12.00
$ 8.50
An employee could purchase a maximum of 5,000 shares ($50,000 / $10 per share FMV on grant date)
on August 31, 2013, representing $25,000 relating to 2012 and $25,000 relating to 2013.
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• Annual limit on stock purchased.
IRC §423 limits the purchase of stock under a qualified plan to no more than $25,000 of stock each
calendar year based on the FMV determined at the time of grant. See Exhibit 3-9 for an example of how
the $25,000 limit is calculated. If an employee has the right to purchase more than $25,000 in a calendar year, none of the purchase qualifies for beneficial tax treatment under IRC §423 and the entire offering may be disqualified. Grants of other equity awards such as nonqualified stock options or restricted
stock units are irrelevant when determining the $25,000 limit. The $25,000 limit increases by $25,000
for each calendar year that an option is outstanding.3 If an offering overlaps one or more calendar years,
the unused portion of the $25,000 limit may carry over to subsequent years of the same offering period
and an employee may purchase more than $25,000 in a calendar year. See Exhibit 3-10 for an example
of the carryover of the $25,000 limit. If an offering period exceeds one year calendar year, the stock purchased will apply against the $25,000 limit for the earliest year of the offering period. The limit for each
succeeding year is applied in order.4 (Note – The Plan may have a lower limit on the number of shares
that may be purchased in a calendar year and restrict the carryover of the $25,000 limit.)
• Not transferable.
The plan must specify that the option is not transferable other than by will or the laws of descent and
distribution. Only the employee may exercise the option to purchase the shares.
3.4.5. Develop and document appropriate internal controls for verifying the requirements of qualified plans
have been met. Document the administrative processes, as discussed in Section 4, General Administration.
Identify how the $25,000 limit will be calculated and document the calculation at each purchase.
3.4.6. Adherence to the IRC §423 requirements is determined at the time the option is granted. The
grant date is normally the first day of the offering period, provided the terms of the offering are fixed and
determinable. To establish the grant date at the beginning of the offering period, the maximum number of
shares an employee may purchase must also be specified. For this purpose, the $25,000 limitation discussed
above is not sufficient. The maximum number of shares must be a specific number of shares or a formula,
provided the maximum number of shares per employee can be determined. If the terms are not fixed and
determinable at the beginning of the offering period, the grant date is the purchase date. This treatment
can have a profound impact on the employee tax consequences discussed in subsection 8.3.
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3.4.7. If the terms of an option are inconsistent with the plan or the offering under the plan, the option
will not be treated as granted under a 423 plan. In addition, none of the options granted under the offering will be eligible for the preferential tax treatment.5 An oversight can taint the beneficial tax treatment of
the entire offering. For example, if the definition of compensation in the Plan includes commissions and a
commission payment to an employee is overlooked when calculating employee contributions to the Plan,
the equal rights and privileges requirement will be violated. All purchases during the offering period will be
tainted (i.e., will not be treated as purchases under a qualified plan) and employees will not receive beneficial tax treatment. The employees will be taxed on the FMV on the purchase date minus the purchase price
at the time of purchase. One offering period’s disqualification will not affect other offering periods that
meet the IRC §423 requirements.
3.4.8. If an option with terms that are inconsistent with the terms of the plan or an offering under the
plan is granted to an employee who is not entitled to the grant under the terms of the plan or offering, the
option will not be treated as having been granted under a 423 plan. However, the grant of the option will
not disqualify other options granted under the plan or offering. If, at the time of grant, an option qualifies
as an option granted under a 423 plan, but after the time of grant one or more of the requirements is not
satisfied with respect to the option, the option will not be treated as granted under a 423 plan. This failure
to comply with the terms of the option will not disqualify the other options granted under the plan or
offering.6
3.5. Nonqualified Plans.
3.5.1. Plans that do not meet the requirements of IRC §423 are nonqualified plans. A nonqualified plan
may be similar to a qualified plan, but the design of a nonqualified plan has more latitude since the requirements of IRC §423 need not be met. For purposes of this publication, direct purchase plans (i.e., plans that
only facilitate the employee purchase of company stock with no discount or match) are excluded from the
discussion of nonqualified plans because these plans are typically noncompensatory, have no tax consequences, and result in no accounting charge.
3.5.2. A nonqualified plan should be structured to meet the specific objectives of the company. The resulting plan may be similar to a 423 plan, but minor differences in plan design can occur. For example, the plan
may limit employee participation or provide different benefits for different employee groups. The nondiscrimination requirements and equal rights and privileges features of IRC §423 are irrelevant to nonqualified
plans. The plan may provide for extended offering periods or offer a discount of more than 15% from the
current FMV of the stock. In lieu of allowing the purchase of shares at a discount, the company may provide
matching contributions in stock or cash. The amount of stock that may be purchased under the plan may
be unlimited. Standard functionality of recordkeeping systems may not support some of the provisions of
nonqualified plans.
3.5.3. Nonqualified plans generate a larger corporate tax benefit than qualified plans because a corporate
tax deduction is allowed for the income reported by the employee on the purchase of the stock. The corporate tax deduction associated with qualified plans is limited to income recognized upon disqualified dispositions. No corporate deduction is permitted for qualified dispositions. See subsection 8.5 for a more detailed
discussion of the corporate tax ramifications of qualified and nonqualified plans.
Mergers and Acquisitions
When a company merges with or acquires another company with an ESPP, the transition process
requires special handling. Review a copy of the merger agreement to determine how the ESPP
will be treated. Identify the exchange ratio that will be used. Address issues associated with
Section 6039 reporting, disposition tracking, and cost basis reporting.
Determine how employees participating in the current offering will be treated. Participation
by non-US employees adds complications. Identify new countries where the acquired company
has employees and determine whether the ESPP will be offered in these new countries. Address
country-specific requirements related to the merger. Develop a detailed project plan to ensure
the appropriate issues are addressed, including system transition issues. Keep management
up to date on potential issues and problems. Communicate critical details to employees to
avoid misunderstandings.
3.6. Issues Related to Non-US Employees.
3.6.1. ESPPs offered to non-US employees may be designed solely as a 423 plan, as a 423 plan with a
separate non-423 plan component, or as an omnibus plan accommodating both 423 and non-423 requirements. There are advantages and disadvantages to each of these approaches. When selecting an approach,
consider the potential need for a staggered rollout of a global ESPP to allow time to address the complexities and the pre-implementation requirements.
3.6.1.2. Another approach is to offer a 423 plan in the US and a non-423 plan outside the US; however,
the offering of two plans often means higher administrative costs and may be difficult if the company
has mobile employees. If the non-423 plan is a stand-alone plan, then it must receive separate shareholder approval (due to stock exchange rules, rather than 423 plan requirements), and have a separate
share pool, and prospectus. The company also must complete any compliance filings or registrations for
the 423 plan and the separate non-US plan. An employee who moves to another country and becomes
an employee of the local entity leaves one plan and must re-enroll in the other plan. When a US employee moves outside the US to be employed by a non-US employer, the IRC §423 employee tax benefit will
be lost. (In contrast, a mobile employee who is temporarily assigned to another country but continues as
an employee of the home country entity does not lose the tax benefit.) On the other hand, the company
would be free to offer participation in the non-423 plan as it sees fit, regardless of the type of entity
or local compliance issues. Another advantage of maintaining separate plans is that there is no need
to consider whether any modifications made to the 423 plan trigger compliance issues for employees
outside the US.
3.6.1.3. The third possible structure for global ESPPs is an omnibus plan that accommodates both 423
and non-423 components. This approach is permitted under the IRC §423 regulations and avoids some
of the difficulties with the other two approaches. The plan may have one share pool (as long as the
shares available under the 423 plan are quantified), one prospectus (although the terms of the non-423
plan must be disclosed), and a single set of compliance filings. The company must identify which foreign
subsidiaries are in the 423 plan (and whether they are in a separate offering) and which entities are in
the non-423 plan. As mobile employees move from one employer to another, they do not need to reenroll. However, US employees may lose the IRC §423 benefit if they move from the 423 component of
the plan to the non-423 offering. If plan changes are made, whether to the non-423 or 423 plan, the
company must consider both what approvals must be obtained to accommodate the changes and any
compliance implications.
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3.6.1.1. A plan designed solely as a 423 plan is easiest to administer, but the company may not be able
to offer the plan in all jurisdictions where employees reside. Administration of the plan is easy because
there is one share pool to track, one prospectus to prepare, and one plan to manage from a compliance
standpoint. If US employees move to work for a foreign subsidiary, they may continue to participate in
the 423 plan without a loss of benefits. Separate offerings as discussed in paragraph 3.4.3 in non-US
jurisdictions can be used to accommodate local legal requirements; however, there may be situations
where the company’s foreign structure or local legal requirements cannot easily fit within the confines
of a 423 plan. For example, a company may wish to offer the ESPP to employees of an entity that is not
a subsidiary or to avoid having to offer the ESPP to employees in a country where compliance is difficult,
but be obligated to because the entity flows into a designated subsidiary as a result of a “check-thebox” election. A “check-the-box” election is a corporate tax election that allows the company to treat
certain foreign entities as US entities.
3.6.2. Where an ESPP is offered to employees outside the US either as a 423 plan or the 423 component of
an omnibus plan, the IRC §423 regulations permit separate offerings for employees working for a specific
subsidiary or group of subsidiaries to accommodate requirements under local law. Administrative errors are
more frequent for non-US employees (e.g., excluding eligible employees or defining compensation incorrectly). Because such errors may disqualify an entire offering, consider using separate offerings for non-US
employees.
3.6.3. There are specific design features that should be included in the ESPP to ensure compliance with
local legal requirements or to allow a company to take advantage of tax benefits outside the US. These
features may form the basis of a separate offering under a 423 plan or they may be available through a
non-423 plan.
3.6.3.1. Outside the US employees have employment agreements, rather than working at will, and may
be subject to specific protections under local law or agreement. For this reason, a company may need
to accommodate different definitions of “employee” in different jurisdictions and the plan should be
designed to anticipate this need. In some jurisdictions, companies must offer any benefits, including
the right to participate in an ESPP, to all employees or risk claims of discrimination. Therefore, the ESPP
should allow the company to establish a definition of employee on a jurisdictional basis so as to include
employees who are part-timers, on a fixed-term of employment, or on a protected leave of absence
where necessary.
3.6.3.2. Consider whether employees should remain eligible to participate in the plan during a nonworking termination notice period. Employees outside the US may be entitled to a notice period when
employment is terminated. Sometimes employees continue to work during this notice period, but other
times it is a non-working notice period. In both cases, the individual is considered an employee for local
law purposes. The Plan should address whether termination will follow local law or strictly track whether
the employee is providing services. Details about changes in employee status that are conveyed to
Equity Compensation should include appropriate information so that the plan provisions can be properly
followed.
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3.6.3.3. The definition of compensation for ESPP purposes, as discussed in paragraph 3.2.5, should
consider variations by job classification and local jurisdictional differences. Employees in certain countries
may be entitled to “thirteenth” month salary, holiday pay, and other forms of compensation. Companies
need to consider whether these items are eligible compensation for purposes of the plan and, if so, how
this compensation will be considered in determining the contribution percentage.
3.6.3.4. Because some countries prohibit deductions from compensation for purposes of participating in
an ESPP, consideration should be given to permitting contributions by check, wire transfer, or lump sum
payment. Allowing contributions in the form of lump sums, rather than deducting a percentage of pay,
may avoid the need for a special approval from labor authorities in some countries.
3.6.3.5. Some countries allow employees to contribute to an ESPP by payroll deduction, provided that
the funds are held in a separate bank account. In some jurisdictions these accounts must also be interestbearing. The plan should allow for funds to be held in a bank account and interest paid, if necessary
under local law.
Footnotes
IRC §1.423-2(c)(3)
IRC §1.423-2(f)(5)
3
IRC §1.423-2(i)(4)
4
Ibid
5
IRC §1.423-2(a)(4)
6
Ibid
1
2
4. General Administration
4.1.Overview.
4.1.2. Primary ESPP activities may occur only a few times a year. Because
it is easy to forget some of the many steps in the process, documentation of administrative procedures is important. Exhibit 4-1 summarizes the
major activities in administering ESPPs. Section 5, Plan Enrollment; Section
6, Contributions to the Plan; and Section 7, The Purchase, include more
detailed process charts relating the specific activities of each section. Each
section discusses the overall process, but each company’s processes will
reflect its unique needs and resources. These recommendations should be
considered general guidelines and applied as appropriate.
4.2. Plan Details.
4.2.1. Each plan is unique and has distinct attributes and administrative
requirements. Plans may have very broad terms or narrow terms. The key
features to include in a plan document include:
• Limits on number of shares per plan, offering, or employee
• Eligibility requirements
• Foreign subsidiary participation
• Compensation definition
• Allowable contribution methods
• Maximum contribution amounts
• Methodology for determining purchase price
• IRC §423 requirements, if applicable
• Offering and purchase periods
• When participants have the right to change contribution rates
• Treatment on termination, leaves of absence, and other employee
changes of status
• Post-purchase restrictions on sale or transfer of shares
• Consequences of a low or depleted share pool
• Impact of change in corporate structure
Equity
Compensation
most often
has primary
responsibility for
administering an
ESPP, but in some
companies other
departments can
hold the primary
responsibility.
19
| Ge neral Adm inistratio n
4.1.1. Close coordination between internal and external parties is
required to ensure the ESPP is administered efficiently and effectively.
Payroll’s responsibilities may include deducting employee contributions
from each paycheck, tracking contributions during a purchase period, and
refunding excess contributions to the employee. Coordination with Payroll
may be particularly challenging when the payroll process is outsourced to
a third party or when the payroll function is decentralized, as is frequently
the case for non-US employees. Financial Reporting is responsible for
calculating the associated expense and meeting various financial reporting requirements. Companies whose plans include more complex features
may use third-party vendors to perform financial reporting calculations.
Human Resources is typically responsible for the plan design and communication, ensures eligible participants are identified and those who
elect to participate are able to participate, and maintains the data regarding changes in employee status. Legal is responsible for adherence to a
variety of legal requirements, including SEC registration and reporting
requirements, exchange controls, and other aspects of the plan operated
outside the US . The transfer agent issues the shares purchased under the
plan. Corporate Tax considers the deductibility of certain plan costs. The
designated brokerage firm(s) deposits the shares into employee accounts
and facilitates employee access to and sale/tracking of the shares after
the purchase. See the appropriate sections of this publication for detailed
information regarding coordination with internal and external parties,
recommended steps in the process, and appropriate internal controls.
Develop a standard template to document the plan requirements. Document how the requirements are incorporated into the administrative processes, system functionality, and documentation provided to employees. Pay particular attention to new plans implemented or changes in plan requirements.
4.2.2. Use unique, company-assigned employee numbers to identify each employee. Numbers should not
be recycled when employees terminate. The company-assigned number may include a prefix that designates a country of employment.
EXHIBIT 4-1: ADMINISTRATION OF AN ESPP
Confirm any changes to the Plan and update processes as necessary
Confirm there are enough shares under the plan for the upcoming purchase(s)
Communicate changes in the Plan to the employees
Confirm any changes in the subsidiaries eligible to participate in Plan and update processes as necessary
Determine eligible employees
Conduct enrollment process and record enrolled employees
Value the award and calculate the period expense
Accumulate cash through payroll deductions, as appropriate
20
Summarize contributions per employee
|
Convert non-US employees’ contributions in local currencies to US dollars
Gen eral Adm inistration
Track payroll contributions
Calculate the number of shares to be purchased
Execute purchase
Issue shares (transfer agent)
Deposit shares into employees’ accounts
Refund or carry forward excess contributions
Calculate and collect tax withholding, if required
Track and report disposition of shares, if required
Report purchase information to internal departments or international entities, if required
Perform tax reporting, upon purchase and at year-end
4.3. Stock Plan System Functionality.
4.3.1. The stock plan record-keeping system may incorporate various software products, including the
record-keeping system, an employee portal, and a financial reporting package. The system may be used
internally by the Company or by a third-party outsourcer. Most commercially-available systems handle the
requirements of qualified plans; however, the support of nonqualified plans with unusual design features
may be limited. When selecting a vendor for an ESPP, the request for proposal should seek information
tailored to the unique needs of the plan. Some common questions regarding the administrative functionality of stock plan systems are summarized in Exhibit 4-2. Review the contract for service closely to ensure it
incorporates all requirements for supporting the plan and types of participants (e.g., non-US-based).
4.3.2. Understand the functionality of the stock plan record-keeping system and how it provides data
to Financial Reporting. Establish and document a process to provide required information to value ESPP
awards. See Section 11, Financial Reporting, for a more detailed discussion.
EXHIBIT 4-2: COMMON QUESTIONS REGARDING
THE ADMINISTRATIVE FUNCTIONALITY OF STOCK PLAN SYSTEMS
Plan Design
• How does the system support the unique requirements of the plan (e.g., matching shares, reset features, rollover
of contributions, etc.)?
• Can the system support multiple offerings covering the same time period?
• What methods of tracking fair market value does the system support? Can the system support multiple fair market values?
• How does the system calculate the $25,000 limit for qualified plans?
• Does the system support fractional shares? How are fractional shares handled?
General Administration
• What information is maintained in the stock plan record-keeping system (e.g., employee eligibility, employee
contributions, increases or decreases to contributions)?
• How is the stock plan record-keeping system integrated with other systems?
• How does the system support post-purchase restrictions?
• How does the system support selling shares immediately after purchase?
Plan Enrollment
• What information is provided to the employee on-line?
• How are country-specific requirements handled?
• How are hard-copy enrollment forms processed?
• What are the interactive voice response (IVR) capabilities?
• Which languages are supported?
Contributions to the Plan
• Does the system accept multiple contribution files?
• Does the system accept contribution files in various formats?
• How does the system handle contributions in non-US currencies? What exchange rate is used for the translation
from local currency to dollars?
• How are lump sum payments handled?
• How does an employee change the contribution rate during an offering period?
• Can the system limit the number of times an employee may change the contribution rate during an offering period?
• How does an employee withdraw from an offering and how are contributions refunded to the employee?
• How does the system support testing of the contribution data during the contribution period and/or before the
purchase?
Purchases
• How soon after the purchase can employees access shares in their accounts?
• What reporting is provided to non-US employees?
• In what currencies can the employees receive funds?
• How are post-purchase restrictions on the sale of shares handled?
• Are shares held in an omnibus account or an individual employee’s brokerage account?
• Are individual employees’ brokerage accounts limited-purpose or full-service accounts?
• Are there any countries where individual brokerage accounts cannot be supported?
Tax Requirements
• How does the system handle required tax withholding?
• How does the system track disqualified dispositions?
• How does the system track qualified dispositions?
• How does the system support Form 3922 reporting requirements?
• How does the system support Form 1099-B and the cost basis reporting requirements?
Employee Communications
• What on-line communication tools are incorporated in the system?
• Can the on-line communication tools be modified?
• What information is available on the employee portal (e.g., employee contribution amounts, refunds, purchase dates)?
21
| Ge neral Adm inistratio n
• Are employee accounts activated at the enrollment date?
4.4.Outsourcing.
4.4.1. The company may outsource certain aspects of ESPP administration. The processes discussed in this
publication will apply regardless of whether the company outsources plan administration; however, the
group responsible for implementing the processes may differ. In all cases, the Company maintains the official books and records in addition to retaining overall responsibility for the internal controls. In general, the
Company:
• Determines eligibility of employees
• Communicates the plan
• Collects and tracks contributions from the employee
• Tracks status changes
• Refunds excess contributions to the employee
• Prepares Form W-2
• Manages share pools
The Company may outsource:
22
Gen eral Adm inistration
|
• Processing enrollments
• Calculating the purchase price, shares, limits, and employee purchase
• Valuing the award and calculating the period expense
• HRIS management
• Disposition tracking
• 6039 Reporting
In some cases the company may use a hybrid approach. In this case the company may fully outsource for
some jurisdictions, while for others, the company handles all aspects of plan administration and merely
transfers a file to the broker to advise them how shares are to be allocated into the employee’s brokerage
accounts.
4.4.2. Multiple vendors may be required to administer ESPPs. One vendor may be responsible for the
employee interface and another for 6039 reporting. Using multiple vendors for various parts of the process
increases complexity. Depending upon the services provided, these vendors may need only a subset of the
information stored in the stock plan record-keeping system. In cases where vendors must share information,
the data should be transferred through the company. In this way the company can certify the timeliness,
correctness, and completeness of the vendor-to-vendor transfers. See previous GPS publications for a more
detailed discussion of working with an outsource provider.
4.5. Issues Related to Non-US Employees.
4.5.1. ESPPs offered to employees outside of the US may not operate in the same manner as they do in
the US. For legal, compliance, or tax reasons, the plan may need to be implemented differently from one
jurisdiction to another, one company to another, or one group of employees to another. Before offering the
plan to non-US employees, the following areas must be reviewed:
• Acceptability of the enrollment process under local law
• Contribution methods (e.G., Payroll deductions, lump sum payments, special authorization requirements)
• Capability of the local payroll system to process contributions via payroll deduction
• Requirements that employee contributions be held in a separate account or interest be paid on the
contributions
• Special procedures required when shares are purchased
• Taxability of the purchase
• Payment of required tax through payroll withholding or other means
5. Plan Enrollment.
5.1.Overview.
5.1.1. Any employee who meets the eligibility requirements discussed in
paragraph 3.2.2 may participate in an ESPP; however, an employee must
take specific steps to participate in the Plan. Once an employee enrolls in
the Plan, contributions are deducted from the employee’s paycheck during the offering period subject to the limitations of the Plan. The enrollment form authorizes Payroll to deduct contributions from the employee’s
paycheck. See Section 6, Contributions to the Plan, for a discussion of
the issues regarding contributions. Plan provisions may allow employees
to change the level of contributions to the Plan during an offering or
withdraw from the Plan. See subsection 6.3 for discussions of changes
in contribution rates and withdrawal from a Plan. Enrollment in a plan
usually covers all future offering periods and continues until the employee
withdraws from the Plan or terminates employment. Exhibit 5-1 summarizes the significant activities in the enrollment process.
EXHIBIT 5-1: ENROLLMENT PROCESS
Before Enrollment Period Begins
Determine eligible employees
Identify employees who require special handling
(e.g., new hires, employees without on-line access)
Alert appropriate internal personnel (e.g., local human resources)
of enrollment period
Communicate open enrollment to employees and include
required disclosures
During Enrollment Period
Advise employees one week before enrollment period ends
Employees enroll in Plan and establish contribution rate
Confirm enrollment and contribution rates with employees
who enroll in Plan
After Enrollment Period Ends
Prepare file summarizing contribution rates by employee by payroll and
transmit file to the appropriate payroll for processing
Estimate the number of shares required for purchase and
advise appropriate department
5.1.2. Efficient and effective communication with employees regarding
the benefits of the plan and the administrative processes for participating
in it will increase employee participation. Section 10 discusses employee
communication in more detail.
23
| Plan enrollm ent
Establish enrollment period start and end dates
During the
enrollment
process, an
employee elects
to participate
in the Plan
and chooses
how much to
contribute as a
fixed amount per
pay period or
as a percentage
of after‑tax
compensation in
accordance
with the Plan.
5.2. Enrollment Process.
5.2.1. An ESPP is an offer to sell stock of a company to its employees. As with any offer to sell publicly traded
securities, the company must provide employees with a prospectus summarizing the significant features of the
Plan. If the plan is offered to employees outside the US, the offering may require registration or an exemption
from registration for the offering to be made. Some countries may require the offering to be made through a
licensed financial advisor in the country. In addition the company may provide additional information to help the
employee to make an informed decision about investing in the Plan. This additional information may include:
• A summary of the Plan benefits and risks
• The mechanics of participating in the Plan
• Instructions for withdrawing from the Plan
• Instructions for changing Plan contributions
• The process for purchasing shares
Where possible, electronically distribute the information. Consult Legal to ensure the communications meet
the company’s disclosure requirements. See Section 10, Employee Communication, for a full discussion of
best practices related to employee communications.
24
|
Plan enrollm ent
5.2.2. An employee who meets the eligibility requirements and chooses to participate in the Plan must
formally enroll during the enrollment period. An enrollment period has a specific start and end date. When
establishing the enrollment period, allow sufficient time at the end to process the enrollments prior to the
beginning of the offering period. There is no requirement that an employee participate in the Plan, and no
employee may elect to participate after the enrollment period ends.
5.2.3. To enroll in the Plan the employee must complete an enrollment form. The enrollment form specifies the contributions to be made to the Plan from the employee’s compensation and provides the employee
authorization that allows the company to deduct such contributions and, where relevant, to withhold taxes.
The enrollment form may also provide employee authorization for a quick sale of the shares purchased as discussed in paragraph 3.3.7. Enrollment may be through an on-line system, IVR (interactive voice response) technology, or by hard copy. On-line enrollment systems simplify administration by minimizing human intervention,
facilitating employee access to enrollment information, and minimizing data entry errors. On-line access may
be limited in certain locations such as remote work sites. In those cases, IVR or paper enrollment forms may
be required. Additional internal controls may be required when using paper enrollment forms as discussed in
paragraph 5.3.3. The enrollment method may be limited for non-US employees in certain jurisdictions under
local law. See subsection 5.4 for a further discussion of enrollment issues for non-US employees.
5.2.4. On-line enrollment systems are available through a variety of vendors. These systems frequently can
process employee enrollments, changes in contribution rates, and withdrawals from the Plan. The enrollment process can be outsourced to a third party. Activities that can be outsourced include:
• Communication regarding the Plan and the enrollment process
• Employee enrollment during the enrollment period
• Summarization of employee contribution rates for transmission to payroll
• Changes in employee contribution rate
• Withdrawals from the Plan
The company maintains responsibility for determining employee eligibility and transmits a file of eligible
employees to the third-party vendor prior to the enrollment process.
5.2.5. A brokerage account may be established for the employee during the enrollment process. Establishing the employees’ individual brokerage accounts at this time will facilitate the purchase of the shares at the
end of the offering period. In certain circumstances initialization of the employee brokerage account may be
delayed until purchase if experience shows a significant number of employees withdraw from the Plan prior
to the purchase date.
5.2.6. The process details and the group responsible for each activity described in Exhibit 5-1 depends upon
a variety of factors, including the use of third-party vendors, system capabilities, centralization/decentralization of administration, and participation of non-US employees. For example, a company may outsource
certain aspects of its enrollment process. In that case, the company determines which employees are eligible
to participate in the Plan and transmits a file to the third-party vendor. The vendor communicates with the
employees, oversees the enrollment process, and provides Equity Compensation with a file that summarizes
employees’ contribution elections. Equity Compensation distributes the details of the contribution elections to
the appropriate payroll group. Payroll withholds employee contributions from each paycheck.
5.3. Post-Enrollment Activities.
5.3.1. After the enrollment period ends, summarize the employee contribution rate by employee and appropriate payroll. When Plan administration is centralized, this process is usually handled by Equity Compensation, which transmits the contribution rate to local payroll for processing. When Plan administration
is decentralized, the employing subsidiary may summarize the contribution rate for appropriate employees
and transmit the information directly to local payroll.
5.3.2. Estimate the number of shares required for purchase based on the initial employee contribution rate.
Validate that sufficient shares will be available at the purchase date.
5.3.3. Confirm the receipt of the enrollment form and verify the appropriate contribution rate with the
employee. For on-line elections, the confirmation may be a reference number automatically provided by the
system when the enrollment form has been completed. Confirming enrollment is critical if hard-copy enrollment forms are used so as to maximize data integrity. As discussed in paragraphs 3.4.7 and 3.4.8 problems
with the enrollment process could jeopardize the favorable tax status of qualified plans.
5.3.4. Coordinate with Financial Reporting to provide the necessary data (e.g., employee ID, contribution
rates, contribution amounts) to perform the expense and tax calculations. Financial Reporting will also need
to be notified of subsequent changes such as terminations and contribution changes.
5.4.1. The method of enrollment may be different or limited in some countries. If non-US employees are
offered the right to participate under a qualified plan, then they must be provided with a copy of a prospectus before deciding whether to participate. If the company operates a nonqualified plan outside the
US, then the US prospectus requirements do not apply to the offering. The laws of the countries where the
employees reside may require similar or more elaborate disclosure be provided to employees as part of the
enrollment process.
5.4.2. To comply with securities laws in some countries, the company may need to provide employees with
disclosures or other materials that meet local securities law requirements. Often these materials must be
provided to employees at the same time as other materials about the plan and while they are able to enroll
in the program. Such documents may include both information about the risks of participating in the plan
and tax and/or currency exchange information. Some countries consider the offering of an ESPP to be a
public offering of securities and require that a registration or prospectus filing be completed before the plan
is offered to employees. Alternatively, a summary of the plan along with a list of eligible participants may
need to be lodged with securities authorities before enrollment starts or within a certain period thereafter.
If advance approval is required, the company should plan accordingly to ensure that the offering does not
need to be delayed in the jurisdiction until the necessary governmental approval is in place.
5.4.3. Some countries limit the use of an employee’s paycheck and how much of the paycheck may be
used to contribute to a foreign ESPP. The company may need to seek approval from a labor authority in a
jurisdiction before local employees contribute funds from their paychecks. In a few countries, the employees must sign a special consent form to participate in the plan. These forms are in addition to any enrollment forms that the company may be using. In some countries a representative of the employees must first
agree to the plan terms and agree that contributions may be taken via payroll deduction before enrollment
materials are distributed to employees themselves. The plan may need to be included in certain local work
rules before the enrollment process begins. Lastly, it may be necessary to translate the enrollment form, or
at least the portion of the form that authorizes the payroll deductions, to satisfy certain language requirements related to the protection of an individual’s compensation.
5.4.4. Enrollment of non-US employees through an on-line or IVR system may not create a binding contract. It may be necessary to have employees print out the forms and sign them in hard copy to create an
enforceable agreement. This enforceable agreement will allow for contributions through payroll deductions,
authorize tax withholding, and give permission to collect, process, and transfer abroad employee personal
data as detailed on the enrollment form.
| Plan enrollm ent
5.4. Issues Related to Non-US Employees.
25
6. Contributions to the Plan
6.1.Overview.
6.1.1. Once the enrollment period ends, enrollment information is summarized in a file and transmitted to the appropriate payroll group (e.g., US
payroll, local country payroll, AsiaPac regional payroll). The enrollment file
includes a list of employees participating during the offering period and
each employee’s contribution rate. Payroll has responsibility for deducting
contributions from each employee’s compensation as defined by the Plan.
Since US payroll systems include functionality to track contributions for
each employee, Payroll usually assumes responsibility for this tracking and
transmits the information to Equity Compensation before the purchase
date. Payroll systems in other jurisdictions may not include this functionality and alternative tracking methods may be required. See paragraph
6.5.1 for the issues associated with tracking contributions of non-US
employees. Exhibit 6-1 summarizes the significant processes surrounding
contributions to the Plan.
EXHIBIT 6-1: CONTRIBUTIONS TO THE PLAN
Establish and document a process for collecting and tracking employee
contributions
26
c o n tr ibutions to the plan
|
The Plan may
allow employees
to change their
contribution
rates, suspend
contributions for
a specified time,
or withdraw from
the Plan prior to
the purchase date.
Establish and document a process for collecting employee contributions associated with variable pay (e.g., overtime, bonuses, and commissions)
Establish and document a process for employees changing their contribution
rates
Establish and document a process for implementing plan limits, offering limits,
the maximum number of shares per employee, or the $25,000 limit
Identify the group responsible for processing employee changes to contribution
rates
Determine how changes will be communicated to Payroll and reflected in the
payroll system
Establish and document a process for coordinating contribution changes and
terminations with Financial Reporting
Prior to the purchase date, collect contribution data from Payroll and audit the
data to ensure
• Employee changes during the offering period have been reflected
properly
• Contributions are collected for all employees who are enrolled in the
Plan
• Contributions are not collected for employees who are not enrolled in
the Plan
• Contributions are not collected for employees who have withdrawn
from in the Plan
Develop and document a procedure for processing refunds to employees who
withdraw from the Plan prior to the purchase date
Develop and document a procedure for identifying terminated employees and
processing refunds from the Plan
6.2. Contribution Methods.
6.2.1. As noted previously, contributions to the Plan can be in any form, including payroll deductions and
lump sum payments. Lump sum contributions may be an attractive alternative in jurisdictions with few
participating employees. For example, Company ABC has five employees in Country X and uses an outside
vendor to administer local country payroll. The per-person administrative cost of collecting employee contributions through payroll may be prohibitively expensive for five people. Allowing the employees to make
lump sum contributions to the Plan by personal check would minimize the cost of payroll administration. Of
course, this cost savings may be offset by the additional administrative cost of Equity Compensation collecting lump sum contributions from appropriate employees via check or wire transfer. Lump sum contributions
can also be used in jurisdictions where local law prohibits deductions from an employee’s compensation.
Care must be taken to ensure the equal rights and privileges requirement is not violated. Companies that
want to allow employees to make lump sum contributions in lieu of payroll deductions should establish
separate offerings to avoid a violation. See paragraph 3.4.3 for details on separate offerings.
6.3. Changes in Contribution Rates.
6.3.2. Most plans include a feature that automatically withdraws employees from the Plan upon termination and refunds their contributions. No interest is paid on the refunded contributions unless required in
a specific non-US jurisdiction. (See paragraph 3.4.4 for a discussion of the employment requirements for
qualified plans.) Factors to be considered when defining responsibility for identifying terminated employees
and processing refunds from the plan include:
• How Payroll and Equity Compensation receive notification that an employee has terminated
• The tracking mechanism used for Plan contributions
• Frequency of payroll processing
• Administrative and legal requirements for the timing of refunded contributions
For example, if Payroll receives early notification of terminations to facilitate the processing of final paychecks and tracks Plan contributions, local Payroll may assume responsibility for refunding contributions in
the employee’s final paycheck. On the other hand, if Equity Compensation tracks Plan contributions, Payroll
and Equity Compensation are notified of terminations simultaneously, and refunded contributions are paid
by separate check, then Equity Compensation may assume primary responsibility for refunding Plan contributions to terminated employees.
6.4.Testing Contribution Data.
6.4.1. To verify the integrity of the contribution data and minimize problems with the actual purchase,
Equity Compensation should review contribution details during the offering period and/or prior to the
purchase date. This review should include data from local payroll showing actual contributions by employees. The data should reflect any changes in contribution rates, Plan withdrawals, and terminations. Equity
Compensation should test that all employees who have made contributions are enrolled in the Plan and all
employees who enrolled in the Plan have contributions. Reconcile the data as follows:
Employees who enrolled in the plan
Minus Terminated employees
Minus Employees who withdrew from the plan
Minus Employees on leaves of absence with no compensation or contributions
Equals Employees with contributions to the plan
27
| contributions to the p la n
6.3.1. The Plan may allow employees to change their contribution rates, suspend contributions for a specified time, or withdraw from the Plan prior to the purchase date. Unlimited changes to contribution rates
may be allowed during an offering period or a company can allow decreases but not increases or limit each
employee to a specific number of changes. For administrative ease, allow sufficient time for administrative
handling of Plan withdrawals (e.g., prohibit withdrawals in the two weeks prior to the end of the offering period to allow sufficient time to process them before the purchase date). Notify Financial Reporting
about any contribution rate changes since contribution increases will increase the expense recognized. This
includes changes in contribution amounts due to changes in pay (salary, bonuses, etc.). Exhibit 6-1 summarizes the significant activities associated with changes in contribution rates.
6.5. Issues Related to Non-US Employees.
6.5.1. Payroll for non-US employees may be processed locally or in the appropriate region. Frequently the
local or regional payroll does not include functionality to deduct or track ESPP contributions. Manual processes may be required at the local level to administer the ESPP. Additional internal controls may be required
to ensure the integrity of the data. Coordination with numerous payroll groups is administratively difficult.
Each local and/or regional payroll should use a standard spreadsheet to accumulate required data. The
transfer of data should be clearly defined and clarify when the data is required to be provided.
6.5.2. The local jurisdiction may limit the use of payroll deductions. In some circumstances, employee contributions may consist of lump sum payments made during the offering period. Lump sum contributions are
more frequently used for non-US employees for administrative ease or due to restrictions under local law.
As discussed in paragraph 3.4.3, a separate offering may be used to allow contributions by lump sum payments for employees in certain countries. See paragraph 6.2.1 for a more detailed discussion of lump sum
payments.
6.5.3. In certain countries, the employees’ contributions must be held in a separate bank account and/or
interest paid on amounts contributed to comply with certain securities laws or to ensure that certain financial protections on individual salaries are in place. In some countries the separate bank account requirement
may be eliminated if the payroll deductions are immediately sent to the US, even if the purchase is not to
occur for several months. If employees’ contributions must be held in a separate bank account, rather than
comingled in a company’s general account as they are in other jurisdictions, then the offering in which the
contributions are held in the account should be established as a separate offering under the ESPP.
28
c o n tr ibutions to the plan
|
6.5.4. ESPP contributions for non-US employees are deducted in local currency and these funds must be
converted to US dollars prior to the purchase of the shares. The process for exchanging currency should be
considered prior to offering the plan in a particular jurisdiction. Written authorization or a power of attorney from the employee may be required to allow the employer to convert the funds on the employees’
behalf. Incorporate this authorization into the enrollment process to simplify the administration of the plan.
6.5.4.1. In addition to the employee’s authorization, the company may need to obtain approval from or
give notice to the exchange control authorities in a particular jurisdiction before converting contributions
made in the local currency into US dollars. The authorities may need to be provided with a copy of the
plan and a list of the participants.
6.5.4.2. Payroll deductions may be converted each pay period; however, the more common practice
is to convert the funds into US dollars at the end of the period for administrative ease. Converting the
funds at the end of the purchase period means that the employees bear the risk of any currency fluctuation over the purchase period.
6.5.5. Another challenge when offering an ESPP to a global workforce is dealing with the contributions of
employees who move from country to country during a purchase period. See paragraph 8.6.6 for a discussion of the tax issues associated with employee moves.
6.5.5.1. If the employee stays within the same offering under a qualified plan or a nonqualifed plan,
then moving from one country to another may not create significant issues. The employee will simply
continue to make payroll deductions. At the end of the purchase period, the employee’s contributions
will be converted from the various local currencies into US dollars and used to purchase shares.
6.5.5.2. Issues are more complicated when an employee moves from one country to another where
each country is included in a separate offering. The employee may need to withdraw from one offering and to enroll in a different offering because it is on a different basis and/or has different terms. The
company will need to review the plan terms and the offerings to determine whether withdrawal and
re-enrollment is necessary and whether contributions may continue to be made or need to be refunded.
Significant administration may be required to track employee movement between separate offerings and
ensure the proper withdraw/enrollment procedures are followed. Similar issues arise when an employee
transfers between qualified and nonqualified plans.
7.The Purchase
7.1.Overview.
7.1.1. On the purchase date, employee contributions are used to purchase shares. Advance preparation is required to minimize issues associated with the purchase. Paragraph 7.2.1 discusses the steps to be taken
to prepare for the purchase. The steps vary depending upon which
department is responsible for retaining and tracking the enrollment and
contribution data. Frequently Payroll tracks contributions and transmits
details to Equity Compensation immediately prior to the purchase date.
Equity Compensation audits the data prior to importing it into the stock
plan record-keeping system. In other cases Equity Compensation tracks
employee contribution rates, including increases and decreases to the
contribution rate, in the stock plan record-keeping system and advises
Payroll of the appropriate amount to withhold. In this case Equity Compensation reconciles the payroll contribution file with the data in the
stock plan record-keeping system prior to purchase.
7.2. Preparing for the Purchase Date.
7.2.1. As noted in paragraph 6.4.1, Equity Compensation should review
contribution details during the offering period. Reviews should also occur
one to two weeks prior to the purchase date and immediately before
the purchase. If appropriate, process a “practice” purchase to identify
potential issues with the purchase process. In addition to the steps noted
in paragraph 6.4.1, immediately before the purchase Equity Compensation should confirm that terminations have been properly recorded to
ensure that only appropriate employees are included in the purchase. In
addition verify that all employee brokerage accounts have been activated
(assuming shares will be transferred to individual brokerage accounts)
and confirm that sufficient shares are available for the purchase. Confirm
that amounts carried forward from a prior offering period, representing a
fractional share, are properly included as contributions during the current
period. Ensure a process is in place to transfer funds from any non-US
jurisdiction to the US on a timely basis to ensure purchases will not be
delayed. If Equity Compensation tracks employee contributions, reconcile
total contributions in the payroll system to contributions in the stock plan
record-keeping system.
Change of Status
Caution – When Equity Compensation is not timely notified of an
employee change of status such as a termination, the employee
may inappropriately participate in the purchase and shares may
be released to the employee. Develop a process for handling
the inappropriate release of shares. Involve Legal to ensure the
Company’s risks are considered appropriately when resolving
these issues. Document the process.
The purchase
process requires
close coordination
with internal and
external contacts
including Payroll,
Human Resources,
Financial
Reporting,
Legal, the transfer
agent, and the
brokerage firm.
29
| The Purchase
7.1.2. The number of shares purchased equals the employee contribution divided by the appropriate purchase price, taking into account
appropriate share limits (e.g., Company Plan or IRS limits) that need to be
imposed. Subsection 7.3 discusses issues associated with calculating the
purchase price. Since purchases are usually infrequent, detailed documentation of the purchase process will avoid errors and oversights. Exhibit 7-1
summarizes the significant processes surrounding the purchase.
EXHIBIT 7-1: Purchase Activities
Assumptions:
Qualified Plan
Administered internally
Payroll tracks employee contributions to the Plan
The purchase is calculated internally
Whole shares are issued
A broker is used to transfer shares into the employee’s brokerage account
2-3 WEEKS BEFORE THE PURCHASE DATE
Remind Payroll of the deadline for the upcoming purchase
Remind the transfer agent and broker(s) of the upcoming purchase
Confirm all employees have activated their brokerage accounts
Verify sufficient shares are available for the purchase
IMMEDIATELY BEFORE THE PURCHASE DATE
Receive the contribution file and import it into stock plan record-keeping system (or other appropriate system)
Confirm contributions have been recorded for all employees participating in the plan
Confirm all employees are active employees
|
Confirm no contributions have been recorded for employees who withdrew from the plan, are on leaves of
absence, or have terminated
The Purchase
30
Confirm contribution amounts carried over from the prior offering period representing a fractional share are
properly included in this period
PURCHASE DATE
Document the calculation of FMV and the source of the pricing data
Process the foreign exchange conversion for non-US employees to convert contributions to US dollars
Calculate the purchase for each employee
Verify purchases do not exceed plan limits, offering limits, the maximum number of shares per employee, or
the IRS $25,000 limit
Confirm sufficient shares are available for the purchase
Reconcile total contributions to shares purchased, refunds, and carry forward amounts
Instruct the transfer agent to issue shares
Provide instructions to the broker
IMMEDIATELY AFTER THE PURCHASE DATE
Provide purchase data to Financial Reporting, specifying any contribution changes and terminations
Advise employees of purchase details
Notify employees who exceeded the share or contribution limit to adjust their contribution rates
Advise Payroll of the contributions that exceeded contribution limits; Payroll to refund the excess in the next
pay cycle
Track carry forwards of excess contributions representing a fractional share to the next offering period; advise
Payroll as appropriate
Prepare a management report summarizing the purchase
7.3. Calculating the Purchase.
7.3.1. The number of shares purchased for each employee equals the employee’s contributions (including any
carry forward that could not purchase a full share in the previous purchase period) divided by the purchase
price. The purchase price is the FMV of the stock on the purchase date (or the offering date if less and the
plan includes a look-back feature) discounted in accordance with the Plan. The Plan may specify how the FMV
is determined (e.g., the previous day market close or the average FMV for the trading day). If the purchase
period ends on a non-trading day, extra care must be taken to verify the correct FMV is used. Regardless of
how the FMV is determined, verify the price from multiple sources and document the calculation. Calculating
the purchase price for an offering period that has only a single purchase period is straightforward. Calculating
the purchase price when the plan uses overlapping offering periods, resets, and rollovers may be more complicated and different purchase prices may be applicable for employees participating in different offerings.
7.3.2. The purchase may be calculated internally or by a third-party administrator. The calculation is usually
done after market close on the purchase date when the FMV is determined (e.g., price at market close or
the average FMV for the trading day). The number of shares purchased may be whole shares or fractional
shares. See paragraph 3.2.7 for a discussion of issuing whole shares or fractional shares. Confirm that sufficient shares are available for the purchase.
7.3.3. The number of shares available for purchase may be limited by the Plan. The limits may be by Plan, by
offering, or by employee. Qualified plans must limit the amount an employee can purchase to $25,000 for each
calendar year based on the grant date FMV. Paragraph 3.4.4. discusses the calculation of the $25,000 limit in
more detail. Prior to executing the purchase, verify that neither the total purchase nor any individual employee’s
purchase exceeds the appropriate limits. Where limits have been exceeded, excess contributions will be refunded to the employee. Exhibits 3-9 and 3-10 provide examples of limiting the number of shares purchased.
7.3.5. Reconcile the purchase details as follows:
Plus
Less
Plus
Total shares purchased x purchase price
Excess contributions refunded to the employees
Excess contributions carried forward from last offering period
Excess contributions carried forward to next offering period
Equals Total contributions during this purchase period
7.4. Issuing Shares.
7.4.1. Purchased shares may be held by the employee or sold immediately. Shares may be held in a variety
of ways including:
• Deposited in an individual employee brokerage account
• Deposited in an omnibus account
• Direct registration
• Issued to the employee as certificates
Each method of holding shares is discussed below. Brokerage firms and third-party administrators may support one or more methods. The company at its discretion may determine which methods to use. In some
countries the method of holding shares may be limited under local law.
7.4.2. The most common method is to deposit purchased shares into individual employees’ brokerage
accounts. The deposited shares are readily available to the employee and the subsequent sale of shares is
more efficient. The brokerage firm may permit whole or fractional shares to be held in individual employees’ accounts. The employees’ brokerage accounts can be limited-purpose or full-service. Limited accounts
merely hold company stock and cash and may provide the employer with more control over the account.
Full-service brokerage accounts can include other investments. In certain countries the brokerage firm may
be unable to support individual brokerage accounts. To simplify administration most companies use a limited number of designated brokers. If a designated broker is used, the shares are electronically transferred
in block to the brokerage firm, which disperses the shares to the individual employees’ accounts based on
information provided by Equity Compensation. See paragraph 7.4.6 for a discussion of coordinating with
the transfer agent and paragraph 7.4.7 for a discussion of coordinating with the brokerage firm.
31
| The Purchase
7.3.4. Where possible, limit excess employee contributions. In some cases payroll systems permit the
company to stop deducting employee contributions when the IRS and/or Plan contribution limits have been
reached. Because no interest is paid on excess contributions, limiting excess contributions is employeefriendly. In addition administration and employee communications are minimized because there are no
excess contributions to refund to the employee.
7.4.3. An omnibus account is an account in which the assets of more than one person are comingled and the
account is managed by a custodian. Shares purchased from an ESPP would be held in a custodial account at
a brokerage firm or transfer agent for all employees. From the employee’s perspective an omnibus account is
similar to holding shares in a mutual fund in that the employee’s access is limited to his or her own holdings.
Employee reporting in an omnibus account can be in whole shares or fractional shares. Omnibus accounts
cannot hold cash. Proceeds from any sale of the shares or cash dividends paid on the shares purchased would
be distributed directly to the employee or to the employee’s separate brokerage account. Any sales of stock
from an omnibus account would result in transaction fees that would normally be borne by the employee. In
some limited cases, the company may agree to bear the transaction fees on behalf of the employee. An omnibus account may give the company more flexibility to change service providers. In certain countries the use of
omnibus accounts may be limited by exchange control restrictions or other local regulations.
7.4.4. Direct registration allows ownership of shares to be electronically registered on the company’s books
through the transfer agent. A brokerage account or share certificates are not required to hold the shares.
Shares may be sold directly through the transfer agent or later electronically transferred to a broker for sale.
7.4.5. In some limited circumstances individual share certificates may be issued and the shares registered
in the employee’s name. This method is administratively cumbersome since physical share certificates are
issued and mailed to the employee. This may result in significant delays in the receipt of the shares by the
employee and carries the risk that the certificate may be lost or stolen. Issuing of individual certificates can
increase the cost for the company and the employee. For these reasons, this method of delivering shares to
participants is rarely used.
32
The Purchase
|
7.4.6. The transfer agent will issue shares based upon instructions provided by the company. The transfer
agent electronically transfers shares from the share reserve for this purpose to a brokerage account via Deposit/Withdrawal at Custodian (DWAC), electronically registers the shares (DRS), or issues physical certificates. Limiting the number of brokerage firms receiving shares minimizes transfer agent fees. Instructions to
the transfer agent include:
• Name of the applicable plan
• Purchase date
• Total shares
• Number of shares to be issued to each brokerage firm
• Delivery instructions
• Details of any restrictive legends
• Control number
• Reserve name and number
Clarify the purchase process with the transfer agent prior to the purchase date to ensure the information
provided conforms to the transfer agent’s unique requirements. Periodically reconcile Plan reserve balances
with the transfer agent’s records.
7.4.7. Notify the brokerage firm(s) of the shares to be delivered. Provide details for allocating the shares to
the appropriate employee’s brokerage accounts including the:
• Name of the employee
• Number of shares purchased
• Employee account number
• Instructions regarding the sale of shares, as appropriate (i.e., quick sales authorized by employees)
• Control number
Where multiple brokerage firms are used, confirm which firm the employee is using and prepare instructions for each firm. Using multiple brokerage firms creates extra work because coordination with each firm
is required. Limiting the number of brokerage firms minimizes costs and risk of error.
7.5. Post-Purchase Activities.
7.5.1. Immediately after the purchase, advise employees of the purchase details. The following information
should be included:
• Date of offering period
• The purchase date
• The amount contributed
• The number of shares purchased
• An explanation of how the purchase price was calculated, including applicable exchange rate for non-US
employees
• An explanation of how shares will be issued
• Details about when shares will be in the employee’s account and available for sale
• Details about any excess contributions, the reason for the excess contribution, how the excess
contribution will be treated (i.e., refunded or carried forward), and suggestions for minimizing excess
contributions in the future
• An explanation of restrictions on subsequent sale of shares
For taxable transactions (i.e., purchases from nonqualified plans or purchases from qualified plans for nonUS employees), the tax consequences should be summarized and the amount of tax withholding, if any,
disclosed.
7.5.3. Refunds of excess contributions should be processed in the next pay cycle. Provide Payroll with appropriate details to process the refunds. Track carry forwards of excess contributions representing a fractional share to the next offering period and advise Payroll as appropriate. Reset purchase period contributions to zero.
7.5.4. Prepare a report to management summarizing the purchase details, such as:
• Number of employees participating
• Participation rate for the current purchase as compared to previous purchases
• Number of shares purchased
• Number of shares sold immediately
• Purchase price
• FMV on purchase date
• Value delivered to the employees and the gain per share
• Balance of shares in the plan and projected usage of the shares
7.6. Issues Related to Non-US Employees.
7.6.1. Local and/or regional payroll is responsible for providing Equity Compensation with contribution details prior to the purchase date. Coordinating with numerous payroll groups can be an onerous task. A delay in the receipt of information from one payroll group could potentially delay the purchase for the entire
offering. To avoid such issues, implement a policy that if information is not timely received from local payroll
that location will not participate in the scheduled purchase. An additional purchase(s) will be processed to
include late payroll submissions. Consult Legal to confirm the acceptability under local law.
33
| The Purchase
7.5.2. Coordinate with Financial Reporting to provide the final purchase data, information about terminations, and details on changes in contribution rates. This process may involve electronically transmitting a
data file, notifying Financial Reporting that reports in the stock plan record-keeping system are ready to be
accessed, or a combination of both. Expense calculations may be outsourced to a third party. In that case
the data requirements and processes remain the same, even though the responsible party may be different.
8.Tax Issues
8.1.Overview.
8.1.1. The tax treatment available for ESPP shares depends upon whether the plan is qualified or nonqualified. Nonqualified plans are subject to
the general tax rules, which are discussed in subsection 8.2. The special
tax rules that apply to qualified plans are discussed in subsection 8.3.
See Exhibit 8-2 for a comparison of the employee tax consequences of
nonqualified and qualified plans. Exhibits 8-3 to 8-6 provide examples of
these rules.
34
Tax I ssues
|
An ESPP is
considered a
stock option
plan for tax
purposes. The
option is granted
at the beginning
of the offering
period. The option
vests and is
exercised at the
purchase date.
8.1.2. Employers have a variety of tax withholding and reporting responsibilities relating to ESPPs. These responsibilities are discussed in subsection
8.4. See Exhibit 8-7 for a comparison of the employer withholding and
reporting responsibilities relating to nonqualified and qualified plans. Most
states’ withholding and reporting requirements follow federal rules. Except
as noted, the discussion of tax requirements refers to federal and state
rules. In addition the employer may be entitled to a corporate tax deduction for the ordinary income reported by the employee. The corporate tax
implications are discussed in subsection 8.5. Previous GPS publications
address the administrative requirements and internal controls associated
with tax withholding and reporting. (Note – Previous GPS publications can
be accessed at www.scu.edu/business/cepi/.)
8.1.3. US employees who participate in qualified plans are eligible for
special tax treatment. The tax implications for non-US employees participating in qualified and nonqualifed ESPPs are determined under local law,
not US law, and the preferential tax treatment as provided by US law does
not apply. Many countries also allow preferential tax treatment for ESPPs
that would be qualified under local tax laws. Locally qualified plans may
be similar, but are not identical, to US qualified plans. Such qualified plans
are outside the scope of this publication. The tax issues associated with
US qualified and nonqualified plans offered to non-US employees are
discussed in subsection 8.6.
8.2. Employee Tax Consequences – Nonqualified Plans.
8.2.1. Most nonqualified plans are considered stock option plans for tax
purposes. The option is granted at the beginning of the offering period.
The general rule regarding the transfer of property in connection with
the performance of services is incorporated in IRC §83, which states the
transfer of property is taxable income to the recipient/employee. However, the grant of an option to purchase stock does not constitute a transfer
of property.1 Therefore, according to IRC §83, the grant of the option
has no tax impact to the employee. Contributions used to purchase stock
are not tax deductible and contributions by the employee are made with
after-tax dollars.
8.2.2. For tax purposes the purchase of stock through a nonqualified
plan is considered an exercise of an option and taxable to the employee.
The difference between the FMV on the purchase date and the purchase
price is taxable compensation to the employee. This ordinary income is
subject to income and social tax withholding and reporting. When the
stock is sold, the difference between the sales price and the FMV on the
purchase date is a capital gain or loss. The capital gain/loss is short term
if the stock was held one year or less from the purchase date. The capital
gain/loss is long term if the stock was held more than one year from the
purchase date. See Exhibits 8-3 to 8-6 for applications of these rules.
8.2.3. The tax treatment of shares purchased under a nonqualified plan that offers matching shares is
dependent on the plan structure and any restrictions placed on the matching shares. In general the difference in FMV at the purchase date and the purchase price is taxable income to the participant. The matching
shares are taxable when they vest. A complete discussion of the tax treatment of nonqualified plans with
matching shares is beyond the scope of this publication.
8.2.4. If the employee sells substantially identical shares at a loss within 30 days before or after the purchase of ESPP shares in an unrelated transaction, special tax rules apply. IRC §1091 disallows the loss on the
stock sale. The basis of the ESPP shares is increased for the disallowed loss. This transaction is commonly
referred to as a “wash sale.” See Exhibit 8-1 for an example of the wash sale rules.
EXHIBIT 8-1: WASH SALE RULES
• Employee A owns 10 shares of XYZ Co., which were purchased for $100 per share on January 1
• On January 15 Employee A sells the shares for $80 per share
• On February 1 Employee A purchases 10 shares under the XYZ ESPP for $85 per share
Tax consequences:
• No loss is recognized on the sale on January 15
• The basis of the shares purchased on February 1 is $105 per share ($85 purchase price plus $20
loss disallowed on January 15 sale)
• The acquisition date is adjusted to include the period the original stock was held. The new
acquisition date is January 17 for capital gain/loss purposes
8.3. Employee Tax Consequences – Qualified Plans.
8.3.1. IRC §83 also applies to employees participating in qualified plans. The grant date is normally the beginning of the offering period, provided the maximum number of shares any one employee may purchase
has been specified. The maximum number of shares can be a specific number of shares or a formula (e.g.,
$20,000 divided by the FMV of the stock on the first day of the offering), provided the maximum number
of shares per employee can be determined as of that date. If the terms are not fixed and determinable at
the beginning of the offering period, the grant date for tax purposes is the purchase date. As noted above,
the grant of the option is not a taxable event for the employee.
8.3.2. Contributions to the plan are made using after-tax dollars. The purchase of stock under a qualified
plan is considered an exercise of an option, and employees will qualify for beneficial tax treatment if the
following requirements are met:
• The plan meets the requirements of IRC §423 (see subsection 3.4 for a complete discussion
of the requirements of IRC §423)
• The employee holds the stock at least two years from the date of grant and one year from
the date of purchase
• The employee remains an employee from the date of grant to three months before the purchase date
Qualif ying versus Disqualif ying Dispositions
Caution – To receive preferential tax treatment an employee must hold shares purchased under a
qualified plan at least two years from the date of grant and one year from the date of purchase. A sale
of the stock on the one-year anniversary date of the purchase is a disqualifying disposition. For example –
Beginning of the offering period Purchase of the stock Sale of the stock February 1, 2011
February 1, 2012
February 1, 2013
The sale of stock on February 1, 2013, would be a disqualifying disposition. The sale of shares
on February 2, 1013, would be a qualifying disposition.
35
| Tax I ssues
8.2.5. IRC §409A addresses the taxation of nonqualified deferred compensation (NQDC). In some limited
situations the purchase of stock through an ESPP may be considered NQDC, depending on the terms of the
award. With proper planning, nonqualified plans can be designed to avoid the application of IRC §409A. A
complete discussion of IRC §409A is beyond the scope of this publication. Consult tax and/or legal counsel
to confirm the Plan meets the requirements of IRC §409A.
Treatment upon Death
Special rules apply if the employee dies while owning shares purchased under a qualified plan.
In this event the shares are deemed transferred in a qualifying disposition, even if the required
holding period has not been met (i.e., the stock may not have been held two years from the date
of grant and one year from the date of purchase). The ordinary income is the lesser of:
• T
he difference between the FMV of the stock at the grant date and the purchase price at
the grant date
or
•
he difference between the FMV of the stock at death and the purchase price and is reported
T
on the employee’s final Form W-2. No income or social tax withholding is required.
8.3.3. If the above requirements are met, the employee is not taxed upon the purchase of the stock. When
the stock is sold, the sale is a qualifying disposition and ordinary income is recognized in an amount which
is the lesser of:
• The difference between the FMV of the stock at grant and the purchase price as if it were calculated on
the grant date (i.e., 85% of the grant date FMV) or
• The actual gain (sale price minus the purchase price), if any
36
|
Tax I ssues
No income or social tax withholding is required on the ordinary income, but the ordinary income will be
reported on Form W-2 for the year of sale. This requirement applies to current and former employees. See
subsection 8.4 for a discussion of the employer’s reporting requirements. In addition to the reported ordinary income, any additional gain or loss upon the sale of stock is treated as a long term capital gain/loss.
See Exhibits 8-3 to 8-6 for applications of these rules.
8.3.4. If an employee under a qualified plan does not meet the requirements of paragraph 8.3.2 (e.g., the
employee does not meet the required holding period of the purchased shares), the disposition of the stock
is deemed a disqualifying disposition. Ordinary income is recognized upon sale to the extent the FMV at the
purchase date exceeds the purchase price, even if no gain is realized upon the sale of the stock. No income
or social tax withholding is required on the ordinary income, but the ordinary income must be reported on
Form W-2 for the year of sale. The difference between the sale price and the FMV on the purchase date is
a capital gain or loss. The capital gain/loss is short term if the stock was held one year or less from the purchase date. The capital gain/loss is long term if the stock was held more than one year from the purchase
date. See Exhibits 8-3 to 8-6 for applications of these rules.
EXHIBIT 8-2: TAX CONSEQUENCES TO THE EMPLOYEE
Nonqualified Plans
Qualified Plans
Grant
None.
None.
Contributions
Made with after-tax dollars.
Made with after-tax dollars.
Purchase
FMV on the purchase date
minus the purchase price is
taxable ordinary income at
the time of purchase.
None.
Sale
Sale price minus the FMV on
the purchase date is a capital
gain or loss.
Qualifying Disposition - If the stock is held at least two years
from the date of grant and one year from the date of purchase,
ordinary income is recognized on the lesser of:
• The difference between the FMV of the stock and the
purchase price on the grant date, or
• The actual gain (sale price minus the purchase price), if any
If the sales price is less than the purchase price, the difference will be a
long term capital loss. If the sales price is greater than the FMV of the
shares on the grant date, the difference will be long term capital gain.
Disqualifying Disposition - If the stock is not held at least two
years from the date of grant and one year from the date of purchase, ordinary income is the FMV at the purchase date minus the
purchase price. The sales price minus the FMV on the purchase
date is a capital gain or loss.
8.3.5. The wash sale rules described in subsection 8.2.4 may apply to any sale of substantially identical
stock within 30 days before or after the purchase of ESPP shares in an unrelated transaction.
EXHIBIT 8-3: APPRECIATING MARKET VALUE
DURING OFFERING PERIOD AND GAIN ON DISPOSITION
Plan Provisions/Assumptions:
Offering price
85% of fair market value on lower of
FMV on grant date or purchase date
$10.00
$12.00
$15.00
FMV on grant date
FMV on purchase date
Sale price
Calculations:
Purchase price ($10.00 x 85%)
$8.50
Discount calculated at the grant date ($10.00 x 15%)
$1.50
Gain realized on purchase ($12.00 - $8.50)
$3.50
Additional gain realized at sale ($15.00 - $12.00)
$3.00
Total gain
$6.50
Qualified Plan
Tax Consequences:
Disqualified
Disposition
Nonqualified
Plan
Taxable as ordinary income recognized on purchase
date
N/A
N/A
$3.50
Taxable as ordinary income on sale of stock
$1.50
$3.50
N/A
Taxable as capital gain on sale of stock
$5.00
$3.00
$3.00
EXHIBIT 8-4: APPRECIATING MARKET VALUE
DURING OFFERING PERIOD AND LOSS ON DISPOSITION
Plan Provisions/Assumptions:
Offering price
FMV on grant date
FMV on purchase date
Sale price
85% of fair market value on lower of FMV on grant
date or purchase date
$10.00
$12.00
$ 5.00
Calculations:
Purchase price ($10.00 x 85%)
$8.50
Discount calculated at the offering date ($10.00 x 15%)
$1.50
Gain realized on purchase ($12.00 - $8.50)
$3.50
Additional loss realized at sale ($5.00 - $12.00)
($7.00)
Total loss
($3.50)
Qualified Plan
Nonqualified
Plan
Tax Consequences:
Qualified
Disposition
Disqualified
Disposition
Taxable as ordinary income recognized on
purchase date
N/A
N/A
$3.50
Taxable as ordinary income on sale of stock
N/A
$3.50
N/A
Taxable as capital loss on sale of stock
($3.50)
($7.00)
($7.00)
37
| Tax I ssues
Qualified
Disposition
EXHIBIT 8-5: DECLINING MARKET VALUE
DURING OFFERING PERIOD AND GAIN ON DISPOSITION
Plan Provisions/Assumptions:
Offering price
85% of fair market value on lower of FMV on grant
date or purchase date
$10.00
$ 8.00
$ 9.00
FMV on grant date
FMV on purchase date
Sale price
Calculations:
Purchase price ($8.00 x 85%)
$6.80
Discount calculated at the offering date ($10.00 x 15%)
$1.50
Gain realized on purchase ($8.00 - $6.80)
$1.20
Additional gain realized at sale ($9.00 - $8.00)
$1.00
Total gain
$2.20
Qualified Plan
Tax Consequences:
Qualified
Disposition
Disqualified
Disposition
Nonqualified
Plan
N/A
N/A
$1.20
38
Taxable as ordinary income on sale of stock
$1.50
$1.20
N/A
|
Taxable as capital gain on sale of stock
$ .70
$1.00
$1.00
Tax I ssues
Taxable as ordinary income recognized on
purchase date
EXHIBIT 8-6: DECLINING MARKET VALUE
DURING OFFERING PERIOD AND LOSS ON DISPOSITION
Plan Provisions/Assumptions:
Offering price
FMV on grant date
FMV on purchase date
Sale price
85% of fair market value on lower of FMV on grant
date or purchase date
$10.00
$ 8.00
$ 5.00
Calculations:
Purchase price ($8.00 x 85%)
$6.80
Gain realized on purchase ($8.00 - $6.80)
$1.20
Additional loss realized at sale ($5.00 - $8.00)
($3.00)
Total loss
($1.80)
Qualified Plan
Tax Consequences:
Qualified
Disposition
Disqualified
Disposition
Nonqualified
Plan
Taxable as ordinary income recognized on
purchase date
N/A
N/A
$1.20
Taxable as ordinary income on sale of stock
N/A
$1.20
N/A
Taxable as capital loss on sale of stock
($1.80)
($3.00)
($3.00)
8.4. Employer Withholding and Reporting Responsibilities.
EXHIBIT 8-7: EMPLOYER WITHHOLDING AND REPORTING RESPONSIBILITIES
Qualified Plans*
Nonqualified Plans
Grant
None.
None.
Contributions
None.
None.
Purchase
None.
Difference between the FMV at exercise and
the purchase price paid is taxable as ordinary
income. Income tax and social tax must be
withheld. Ordinary income is reported on
Form W-2, box 1.
First transfer
of legal title
of shares
purchased**
Reported on Form 3922 to the IRS and the
employee.
None.
Sale
Qualifying Disposition: Ordinary income on the None.
lesser of:
• The difference between the FMV of the
stock and the purchase price on the
grant date or
• The actual gain.
* Some states do not recognize the preferential tax treatment of qualified plans. In such states, qualified plans are
treated as nonqualified plans.
** U
sually when the purchased shares are transferred into the individual employee’s brokerage account or an
omnibus account.
8.4.1. When a non-qualified stock option is exercised, the difference between the FMV at exercise and the
option price is taxable as ordinary income. Income and social tax withholding are required, and the income
is reported on Form W-2. For tax purposes the purchase of stock from an ESPP is deemed the exercise of an
option. Therefore, the purchase of stock under a nonqualified ESPP is subject to income and social tax withholding and reporting. The difference between the FMV at purchase and the purchase price (i.e., purchase
discount) is ordinary income. For income tax purposes the income is typically treated as a supplemental
wage and tax is withheld using supplemental tax rates rather than regular withholding rates. When year-todate supplemental wage payments from all sources exceed $1 million for an individual in a calendar year,
federal withholding must be increased to the maximum tax rate. The employer is not required to withhold
tax or report income associated with the sale of the stock.
8.4.2. The employee can pay tax related to the purchase discount by:
• Having the appropriate amount withheld from compensation
• Selling a portion of the shares
• Having a portion of the shares withheld to fund the required tax payment
The advantages and disadvantages of each method are briefly discussed below. See previous GPS publications for a more detailed discussion of methods for collecting tax from the employee.
8.4.2.1.The most common method for collecting tax on the purchase discount is withholding the appropriate amount from the employee’s compensation through the regular payroll process. The discount
is calculated and communicated to Payroll as additional income in the current pay period. Income and
social taxes are withheld. The disadvantage of this method is that the employee’s paycheck is impacted.
39
| Tax I ssues
This amount is reported on Form W-2, box
1. No income or social tax withholding is
required. Disqualifying disposition: Ordinary
income on the FMV at the purchase date minus
the purchase price and is reported on Form W-2,
box 1. No income or social tax withholding is
required.
8.4.2.2.An alternative is to sell a portion of the purchased shares to fund the required tax (i.e., sell-tocover). Using this method, the required tax is estimated and sufficient shares are sold to generate cash to
fund the payment. The number of shares to be sold is rounded up to equal whole shares, not fractional
shares, and to cover market fluctuation in the shares. (Market fluctuation is the difference between the
estimate of the proceeds from the stock sale and the actual proceeds from the stock sale.) This method
ensures that the employee’s paycheck for the month of the purchase is not affected by the transaction.
The sale usually occurs on the day after purchase. This method of withholding has administrative challenges for the company because estimating the number of shares to be sold to pay tax and the complications of handling proceeds that exceed or fall short of the required tax requires significant time and
effort. The employee must authorize the sale of the shares. The authorization is typically incorporated in
the enrollment form.
8.4.2.3.Another method is to withhold a portion of the purchased shares to fund the required tax (i.e.,
withhold-to-cover). This method also ensures that the employee’s paycheck for the month of the purchase is not affected by the transaction. The employee’s tax is paid by withholding shares equal to the
amount of tax divided by the FMV of a share. Most companies do not allow for the issuance of fractional
shares. Therefore, the calculation of the number of shares that must be withheld is rounded to whole
shares. See paragraph 8.4.2.4 for a discussion of the accounting implications of rounding shares. The
company credits the current value of the shares withheld against the tax required to be withheld on the
purchase discount. Since no shares are sold in a withhold-to-cover transaction, there are no sales proceeds to fund the employee’s tax. Instead, company funds are used to pay the employee’s withholding
tax liability.
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8.4.2.4.Withholding shares to cover the required tax is commonly referred to as a “tender of shares”.
When shares are tendered from those currently being purchased, the tax withholding must be limited to
the minimum required statutory payment. Tendering shares in excess of the minimum statutory requirements will result in the award being treated as a liability rather than an equity instrument. Using whole
shares to cover the tax may result in slightly more tax than the minimum amount required to be withheld. A company’s external auditors should be consulted to ensure this approach does not affect the
classification of the award as an equity instrument.
8.4.3. Purchases under a qualified plan are not taxable at the time of purchase. Some states do not recognize the preferential tax treatment of qualified plans. In such states, qualified plans are treated as nonqualified plans. When the stock is sold, ordinary income and capital gain/loss are realized as discussed in
subsection 8.3. The employer is not required to withhold income tax or social taxes on the ordinary income.
Ordinary income must be reported on Form W-2, box 1, provided the wages are in aggregate $600 or more
in a calendar year.2
8.4.4. To properly report the sale of stock under a qualified plan, the company must track the disposition
of the stock. This means the company must track the stock held by current and former employees until the
stock is sold. Some companies avoid the issue by implementing post-purchase restrictions such as those discussed in subsection 3.3.6. Frequently the broker or third-party administrator will track subsequent dispositions on behalf of the company and transmit reports summarizing qualified and nonqualified dispositions
to the company. In certain cases, the broker or third-party administrator may calculate taxable income from
the disqualified disposition using purchase price provided by the company. Using a designated broker will
simplify the tracking process. If the information is not available from the broker or third-party administrator,
the company must gather appropriate information directly from the employee.
8.4.5. IRC §6039 requires every company that has transferred legal title of shares acquired under a 423
plan to file Form 3922 for each transfer made during the year. Forms are filed with the IRS and also sent to
the employee or former employee. The reporting requirement applies only to the first transfer of legal title
of shares of stock purchased. Immediately depositing the purchased shares into the individual employee's
brokerage account or an omnibus account is considered the "first transfer of legal title." Post-purchase
restrictions on the sale of shares do not affect the determination of the “first transfer of legal title.” Subsequent transfers of legal title (e.g., sale of the shares) do not require reporting under IRC §6039. Nonqualified plans are exempt from the reporting requirements of IRC §6039. In addition Form 3922 is not required
for an employee who is a nonresident alien for US tax purposes and to whom the corporation is not
required to provide a Form W-2.3
8.4.5.1.The following information must be provided for each transfer:
• The employee’s name, address, and Social Security number
• The name, address, and employer identification number of the corporation whose stock is being
transferred
• Grant date (i.e., beginning of the offering period)
• Purchase date (i.e., date the option was exercised)
• FMV per share on the grant date
• FMV of the stock on the purchase date
• The actual purchase price (i.e., exercise price) paid per share
• Number of whole shares to which legal title was transferred (i.e. fractional shares must be rounded up
to the next whole share)
• Date the legal title of the shares was transferred
• Purchase price per share determined as if the purchase occurred on the grant date
This information is not required if the purchase price is based solely on the FMV at the beginning of
the offering period or the grant date occurs on the purchase date. It is required only if the purchase
price was not fixed and determinable on the grant date, which occurs if the plan has a look-back
feature or the purchase price is based on the FMV at the purchase date.
• Account number
A unique transaction number should be used on each Form 3922 to facilitate IRS matching of
forms. If an employee has more than one purchase per year, each purchase must be reported separately and have a unique account number.
EXHIBIT 8-8: FORM 3922 FILING REQUIREMENTS
Due Date
Other Comments
Paper filing
February 28 of the following year
Permissible only if the company has fewer than
250 reportable transactions
Electronic filing
March 31 of the following year
Required if the company has 250 or more reportable transactions in a year
Employee
January 31 of the following year
Substitute forms may be used to combine multiple transfers on a single form. Substitute forms
must include “substantially the same” information noted above.
8.4.5.2.Frequently a company will electronically file Form 3922 with the IRS and use a substitute form
to distribute to employees. Where appropriate, the company may include additional information for the
employees to explain the information provided and describe the tax consequences of the transactions.
8.4.5.3.Form 3922 can be prepared internally or outsourced. If prepared internally, Equity Compensation is usually responsibility for filing the form. In some companies Accounts Payable, Payroll, or another
department assume responsibility for the filings.
8.4.6. Stock purchased through an ESPP after January 1, 2011, is subject to cost basis reporting (because
the shares are purchased for cash, they are considered “covered” shares). The broker is responsible for
reporting the cost basis at sale to the employee and the IRS on Form 1099-B. The reportable cost basis
includes only the price the employee paid for the stock. To calculate capital gain or loss upon sale of the
shares, the employee must add any ordinary income subsequently recognized in connection with the sale
of stock to the cost basis that was reported on Form 1099-B. The employee will make this adjustment on
Form 8949 when completing Form 1040 in the year of sale.
8.4.6.1 For stock acquisitions on or after January 1, 2011, but prior to January 1, 2013, the broker must
record a cost basis at least equal to the amount the employee paid for the stock. (Note – This may not
be the same as the cost basis for tax purposes.) From 2011-2013, a broker may have, but was not required to, include ordinary income in cost basis reporting.
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The filing requirements of Form 3922 are summarized in Exhibit 8-8. Significant penalties may be incurred for
late filing, not filing the required forms with the IRS, or failing to distribute the statements to the employees.
Cost Basis
The cost basis regulations require brokers to report only the discounted purchase price
as the cost basis. Employees will have to increase the reported cost basis on Form
1099-B by reportable ordinary income from qualifying or disqualifying dispositions.
Companies should be careful to report this income properly on Form W-2 and to advise
employees how to adjust the cost basis of the shares sold to avoid over-reporting
capital gains or underreporting losses.6
8.4.6.2 Although the broker is responsible for filing Form 1099-B, the plan administrator (e.g., the company) typically tracks and maintains the cost basis data. When the shares are purchased in the ESPP and
the plan administrator transfers custody over the shares to the broker, the plan administrator is required
to furnish to the receiving broker a transfer statement that must include the cost basis and acquisition
date of any covered shares. For acquisitions after January 1, 2014, only the amount paid for the stock
will be furnished to the receiving broker.
8.4.6.3For nonqualified plans, calculating the complete adjusted cost basis is relatively straightforward,
since ordinary income is calculated when the shares are purchased. The cost basis of shares purchased
under a nonqualified plan is typically the FMV on the purchase date. This data should be readily available
on the purchase date. For qualified plans, ordinary income is calculated when the shares are sold. Each
purchase lot will have a unique cost basis, which must be separately calculated by the employee after
the sale of shares. When the sale occurs after the shares are transferred to a broker, it is unlikely that the
ordinary income component of cost basis reporting will be calculated by the broker for qualified plans.
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8.4.6.4Coordination is required between the plan administrator and broker to ensure the 1099-B
reporting requirements are met. Processes and responsibilities should be clearly defined. The following
areas should be addressed:
• How the information will be provided to the broker
• Whether the broker identifies ESPP shares on its system
• Whether the broker follows up with the administrator or issuer to obtain the complete cost basis in the
event of a sale of ESPP stock
• Whether the broker provides supplemental information to the employee advising them either:
That the cost basis requires adjustment when reporting the sale on the employee’s tax
return, and/or
The dollar amount of basis adjustment required
8.4.6.5Employee communications should be enhanced to include an explanation of the interaction of
cost basis reporting and reporting the sale of stock for tax purposes. This will minimize misunderstandings and incorrect reporting of the sale of stock and is especially important if the 1099-B includes only
the amount the employee paid for the stock and not the compensatory income.
8.5. Corporate Tax Deductions.
8.5.1. Normally a corporate tax deduction may be claimed for the ordinary income recognized by the employee upon the exercise of stock options. When an employee purchases stock under a nonqualified plan,
the FMV at purchase less the purchase price is ordinary income to the employee. The company is entitled to
a compensation deduction in the same amount provided the employer reports the compensation on a Form
W-2 or the employee reports the compensation on his/her annual tax return.
8.5.2. The sale of stock under a qualified plan may result in a qualifying or disqualifying disposition. No
corporate deduction is permitted under IRC §421(a)(2) for a qualifying disposition. The employer will be
entitled to a deduction upon a disqualifying disposition equal to the amount the employee must include
in income.4 The employer may take this deduction in its taxable year in which the disqualifying disposition
occurred.5
8.5.3. The corporate tax deduction may be limited under IRC §162(m) for certain employees whose
compensation exceeds the $1 million cap for the year. A complete discussion of IRC §162(m) is outside the
scope of this publication. See previous GPS publications for a more detailed discussion of the requirements
of IRC §162(m).
8.5.4. A US tax deduction is only permitted for employees working for the benefit of the US company.
A non-US tax deduction may be allowed for the purchase discount of non-US employees in the location
where the employees work. Certain steps must be taken to secure this non-US tax deduction including
tracking the cost and allocating the cost to the employing companies. A non-US tax deduction may be
available for qualified and nonqualified plans. Any decision to recharge the costs of the ESPP to a non-US
jurisdiction must be discussed with the US issuer’s tax department because it may impact the company’s
larger global tax strategy or transfer pricing arrangements.
8.5.4.1.For the company to obtain a tax deduction for the discount at the time of the purchase, an
agreement needs to be in place between the US issuer and the employing company under the terms of
which the employing company agrees to bear the cost of the ESPP for its employees. This agreement
(i.e., recharge or reimbursement agreement) normally needs to be in place at the time the ESPP is first
offered to the employee. In certain countries a formal recharge agreement is not required to claim a
statutory deduction. To put a recharge agreement in place, an employing company may need to follow
certain administrative steps such as having its shareholders approve the use of funds for this purpose.
Exchange controls should also be considered to determine whether the recharge payment itself requires
the approval of the exchange control authorities.
8.5.4.2.If such a recharge agreement is in place, the company needs to develop certain procedures to
track the purchase of the shares and to charge the cost of those purchases to the employing company.
This record is important for the company to be entitled to take the deduction. A recharge agreement
may also impact the tax consequences for the employees and the employing company in the jurisdiction
where the employees reside.
8.6.1. Outside the US, employees generally will be subject to tax on the amount of the discount at purchase (i.e., FMV at purchase less the purchase price) in the country in which they reside. These non-US taxes
apply to the purchase of shares by employees outside the US regardless of whether they are participating
under a qualified or nonqualified plan. In some countries a special tax exemption may apply to exclude
some portion of the discount from taxation if certain requirements are met.
8.6.2. For most non-US jurisdictions, the FMV of the shares is based on the value of the shares on the
exchange on which they are listed on the day of the purchase. Some countries require that shares be valued
for tax purposes at the average share price over the month prior to purchase, at a weighted-average price,
or at the opening price on the day of purchase. Other countries require that a local bank or broker value the
shares even though the shares are listed on a recognized stock exchange in the US or elsewhere. A company offering a global ESPP should determine which countries require a special tax valuation of the shares
so that value is determined on a timely basis.
8.6.3. Because the purchase generally is a taxable event, a number of administrative and practical hurdles
arise including:
• Meeting the company withholding and reporting requirements
• Paying the employer social tax obligations
• Calculating the taxable amount
• Determining the appropriate tax rate
These administrative issues mean that operating an ESPP outside the US may be more challenging than it is
within the US.
8.6.3.1.The employing company may be required to withhold and report income and social tax on the
discount. In addition, the employing company may be required to pay the employer’s portion of any
social tax on the discount. In some countries, the employer social tax is very high (e.g., 46% uncapped).
8.6.3.2.The calculation of the taxable amount and the associated withholding requires cooperation
between the issuer and the company employing the participant. The number of shares to be purchased
and the price paid for such shares must be determined employee-by-employee. The taxable income resulting from the discount is the taxable value of the shares under local country rules minus the purchase
price. Once the discount is determined, the tax rate can be applied to determine the amount of tax that
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8.6. Issues Related to Non-US Employees.
8.6.3.3.The non-US tax rate generally is based upon the participant’s marginal tax rate. The income is
included in the employee’s compensation in the month in which the purchase occurs and the appropriate marginal tax rate is applied. In some countries, employees are able to factor the discount into their
income over the taxable year, rather than in the month in which the purchase occurs. This income averaging may result in a lower tax rate on the discount.
8.6.4. Once the taxable amount is determined and a country withholding obligation is identified, the company must decide how the tax amount will be collected from the participant and paid to the tax authorities
in the jurisdiction in which the participant resides. The tax may be collected from the employee by:
• Withholding from the employee’s compensation
• Selling a portion of the shares
• Withholding a portion of the shares
The advantages and disadvantages of each method are discussed in subsection 8.4.2. Note – In the US
determining the minimum required statutory payment is relatively simple since the US provides for a flat
withholding rate on supplemental payments. Most countries do not apply flat withholding rates to supplemental payments such as equity compensation. Income from equity awards is generally subject to tax at
regular payroll tax rates.
8.6.5. The purchase of stock of a US issuer under a nonqualified ESPP is also subject to US withholding and
reporting. Non-US tax residents can avoid this requirement by having a Form W-8 BEN – Certificate of Foreign Status – on file with the broker or the company. By completing a Form W-8BEN, the employee certifies
under penalty of perjury that they are neither a US citizen nor a resident alien, and are not subject to certain
US information return reporting and back-up withholding.
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8.6.6. The purchase of shares may trigger taxation in multiple countries if during the offering period
an employee moves from one jurisdiction to another or is a tax resident in more than one country. The
company may be required to withhold and/or report taxes in multiple countries at the time of the purchase. The company should develop a system to identify mobile employees or employees who are resident
in more than one tax jurisdiction and determine how to allocate the discount among jurisdictions for tax
purposes. This requirement may also apply to a US taxpayer participating in the ESPP while a resident of a
non-US tax jurisdiction. In this case the US taxpayer may be liable for tax in the non-US jurisdiction at the
time of the purchase. A complete discussion of the issues related to mobile employees is beyond the scope
of this publication.
Footnotes
IRC § 1.83-3(a)(2)
IRC §1.6041-2(a)(1)
3
IRC §1.6039-1(e)(2)
4
IRC §421(a)(2)
5
IRC §1.421-2(b)(1)(i)
6
ASC 718-740-25-2
1
2
9.Legal
9.1.Overview.
9.1.1. Companies and employees are subject to a variety of
legal requirements relating to ESPPs. Companies must consider:
• Federal, state and local (city or county) tax regulations governing
qualified plans
• Federal and state securities registration and prospectus delivery
requirements
• Stock exchange listing requirements
• The source of shares
(e.g., original issuance verses repurchased on market)
Certain employees are subject to additional legal requirements such as:
• Section 16 officers, who must file SEC Forms 3, 4, and 5
• Section 16 officers and other affiliates, who are subject to Rule 144
for sales of ESPP stock
• Section 16 officers and other individuals with access to material,
nonpublic information, who are considered Insiders and are subject to
trading restrictions such as blackout periods
9.1.2. This publication will focus on unique requirements associated
with ESPPs including:
• Section 16 reporting
• Impact of blackout periods
• Global issues
See other GPS publications for detailed discussions of other legal topics.
9.2. Section 16 Reporting.
9.2.1. Section 16 officers are required to advise the SEC about ownership in the company and changes in their stock ownership. Form 4
– Statement of Changes in Beneficial Ownership of Securities – is filed
periodically upon events changing beneficial ownership. Enrollment in
an ESPP and contributions to the plan are not reportable transactions.
Purchases under a qualified plan are exempt from reporting. Shares
purchased are included in the number of shares owned on the next Form
4 or Form 5 (where they are typically identified in a footnote as ESPP
shares).
9.2.2. A sale of shares purchased under an ESPP is not exempt from
Section 16. The sale must be reported on Form 4 and is subject to the
short-swing profits rule.
Companies and
employees are
subject to a
variety of legal
requirements
relating to ESPPs.
This publication
focuses on some
of the unique
requirements
of Section
16 reporting,
blackout periods,
and global issues.
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Each country has different legal requirements that govern equity compensation for non-US employees. It is important to understand and follow
the requirements in each country where employees will participate in
the ESPP. In many cases the legal issues must be addressed and resolved
before the non-US employees are allowed to participate in the Plan. A
detailed discussion of country-specific requirements is outside the scope
of this publication.
9.3. Blackout Periods.
9.3.1. A blackout period is a period during which the securities of a corporation cannot be traded by Section 16 officers and other Insiders who hold material, nonpublic information about the company and its
affairs. The initial election to participate in an ESPP should be made outside of a blackout period. If so, the
ESPP essentially serves as a 10b5-1 trading plan that has pre-set purchase dates, so that purchases under
the plan are not generally prohibited during blackout periods nor are they affected by the Insider’s possession of material, non-public information. Although blackout periods should not affect the purchase of
shares in an ESPP, a blackout period may restrict the sale of shares after purchase.
9.3.2. Primary responsibility for compliance with blackout periods resides with the employee, not the company. Develop and implement a program to educate the appropriate employees about their responsibilities
regarding blackout periods. As appropriate, notify employees when the trading window is open or closed.
Equity Compensation should work closely with the company-designated broker to ensure the broker does
not process trades during blackout periods. When multiple brokers are used, additional controls must be
implemented.
9.4. Issues Related to Non-US Employees.
9.4.1. Determining the legal and regulatory requirements in each country can be challenging. Filings may
be required from a securities, labor, and/or exchange control standpoint. The filings may be necessary
before the plan is offered in a country, at the time of the enrollment, at the time of the purchase of shares,
when shares are resold, or thereafter. Legal issues may impact all aspects of the ESPP process and may
require the commitment of compliance resources as long as the ESPP is offered to employees in a country.
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Caution – This section is an overview of the legal issues associated with global ESPPs
and is not intended to address country-specific requirements. Noncompliance with local
law may result in civil and criminal penalties. Consult with legal counsel to determine the
country‑specific requirements and the risks associated with noncompliance.
9.4.2. Most companies use outside legal counsel to determine the local country requirements. Because
securities law compliance issues apply to the issuer, rather than to the local employer, best practice is to
manage compliance at the US corporate level. In contrast, the exchange control and labor law issues often
involve both the employing company and the issuer, so compliance may need to be managed on both corporate and local jurisdiction level.
9.4.3. Since each country has its own requirements, best practice is to develop a country-specific administration guide summarizing each jurisdiction’s key requirements. Update this guide regularly or as legal
requirements change. Once a filing has been completed for a country, share a copy and the details of the
filings with the people responsible for the legal compliance and administration of the plan.
9.4.3.1.The offering of the ESPP may raise certain “acquired rights” issues if the plan is offered outside
the US. An “acquired right” is a regularly offered employer-sponsored benefit that is deemed nondiscretionary. The ESPP is more likely to be considered an acquired right under local law than options or
RSU offerings because:
• Employees participate by means of contribution from their salaries
• Participation is offered to all employees working for the entity in the country
• The ESPP is offered continuously, and shares are purchased at each purchase period automatically
unless the employee withdraws from the plan or terminates employment
If the plan is deemed to be an acquired right, the company may need the employees’ consent or to offer
some equivalent benefit should it wish to discontinue or change the ESPP provisions. The income from
acquired rights may also need to be included in employees’ severance calculations upon termination of
employment.
9.4.3.2.Payroll deductions also require the approval of labor authorities in some non-US countries
since portions of employees’ paychecks are used to purchase foreign securities. Many countries restrict
whether an employee’s compensation can be used for this purpose or how much of the compensation
can be used. The labor authorities may require a list of the employees participating in the plan and want
copies of the signed employee consents to participate in the plan before they will allow the company to
offer the plan in the country.
9.4.3.3.Offering the right to participate in the ESPP to employees residing in a non-US jurisdiction may
be considered a securities offering in that jurisdiction. The purchase and the resale of the shares by employees may also be considered a securities offering in the jurisdiction. If the offer of the ESPP is deemed
to be a securities offering in a country, then the issuer may need to register its shares or rights to shares,
obtain an approval from the securities authorities in the jurisdiction, and/or prepare and distribute a
prospectus to employees concerning the offering of securities.
9.4.3.4.Many countries exempt an issuer from the registration, approval, or prospectus requirements
if the offering of securities is restricted to employees, is limited in terms of the number of offerees or
the value of the offering, or is restricted in the manner in which the offering is made to employees. The
issuer should determine whether such exemptions exist in a particular jurisdiction where the employees
reside and, if so, whether they are self-executing or require the company to make a filing or give notice
to the securities authorities and/or the employees. The exemption may need to be renewed periodically
or at each purchase.
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9.4.3.5.Exchange control restrictions may limit the conversion of currency, require special approvals of
the exchange control authorities in a non-US jurisdiction, or mandate procedures be followed in connection with the purchase of shares. These exchange control requirements are discussed in detail in subsection 6.5.4.
10.Employee Communication
10.1.Overview.
10.1.1. Effective communication will increase employee perception of
the value received from the ESPP and should increase participation in the
Plan. A well-thought-out communication strategy is essential to explaining the benefits of the plan to employees. A strong communication
program will take this into account. Describe the plan in a way that allows
someone with minimal understanding of what stock is and how its price
changes to make an informed decision about participating in the plan.
10.2. Communication Strategies.
10.2.1. Communications must be tailored to fit the details of the company’s plan. When communicating, avoid inadvertent messages. Examples
should reflect a stock price that is close to the company’s actual trading
price and show the stock price moving by realistic increments, both up
and down. The communications budget will affect the forms of communication that are used. Most vendors offer cost-effective communications
tools that can help with initial communication and automate ongoing
communication.
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A well
thought-out
communication
strategy is
essential to
explaining
the benefits
of the plan to
employees.
Because ESPPs
are by nature
broad-based,
some eligible
employees will be
less sophisticated
investors than
participants in
other equity
plans.
10.2.2. The communication tools offered to employees should include
tangible tools, if possible, so that employees can run their own scenarios.
This allows them to model “what if” calculations without the company
presenting implausible scenarios.
10.2.3. Some plan communications are mandatory. Publicly traded
companies are required to distribute a plan prospectus that summarizes
the key terms and conditions of the plan. A full discussion of SEC requirements is outside the scope of this publication.
10.2.4. When plans are revised, changes must be communicated in a
clear and straightforward manner that genuinely addresses the reason for
the change. Clear, honest, and direct communication of the change and
what it means for employees is essential.
10.3. Ongoing Communications.
10.3.1. Ongoing communication is important. Exhibit 10-1 summarizes the key components of
communication.
EXHIBIT 10-1: KEY COMPONENTS OF COMMUNICATION
When To
Communicate
What To Communicate
Details of the plan
Tax consequences of the plan
Changes to the plan
How to enroll in the plan
Start of enrollment
period
Enrollment open
How to enroll in the plan
When the enrollment period ends
Required disclosures
1 week before
enrollment period
ends
When the enrollment period ends
After enrollment
period ends
Confirm enrollment status
Confirm contribution rate
Before the purchase
date
Requirements for opening a brokerage account, if any
What to expect upon purchase, including
When the shares will be in the employee’s account
Purchase
Summary of the offering period
Purchase date
Amount contributed
Number of shares purchased
How the purchase price was calculated, including applicable exchange rate for
non-US employees
How shares will be issued
When shares will be in the employee’s account and available for sale
Any excess contributions, the reason for the excess contribution, how the excess
contribution will be treated (i.e., refunded or carried forward), and suggestions
for minimizing excess contribution in the future
Restrictions on subsequent sale of shares
Explanations of the tax treatment of the purchase and sale of the shares
Required tax withholding
10.3.2. Before the enrollment period begins, communicate the details of the plan and how to enroll in it.
Clearly identify the deadline for submitting an election to participate. Remind employees at the beginning
of the enrollment period and again one week before the period ends. As discussed in paragraph 5.2.1,
some of the items that should be included in this communication are the Plan prospectus, a summary of
the Plan benefits and risks, and the mechanics of participating in the Plan. Ensure all communications in
connection with the plan are written in a manner that is comprehensible to a broad range of employees.
Reference other appropriate resources that are available for employee use.
10.3.3. Once an employee has enrolled, confirm enrollment status and contribution rates, electronically or
via hard copy. Before the purchase, communicate what employees should expect upon purchase, including
whether to expect tax withholding. If the plan is a qualified plan, include an explanation of the required
holding period to maximize the tax benefits and explain the difference in tax treatment between qualifying
and disqualifying dispositions.
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Before enrollment
period begins
10.3.4. After the purchase, communicate the purchase price of the shares, when the shares will be deposited into employees’ accounts, and any required tax withholding. If contributions were made in another
currency, disclose the appropriate exchange rate. In many cases, these communications can be automated
using vendor software. If necessary, advise employees of excess contributions, the reason for the excess
contribution, how excess contributions will be treated (i.e., refunded or carried forward), and suggest ways
of minimizing excess contributions in the future.
10.4. Communication Methods.
10.4.1.Employee demographics should be considered in determining which communication methods to
use. Consideration should be given to employees’ access to computers and familiarity with various communication methods. As appropriate, in-person communication should be part of the education effort.
10.4.2. Where possible, formal communications should be done electronically to improve employees’ access to up-to-date information such as the current stock price and provide additional resources for finding
answers to more detailed questions. Any employees who do not have access to computers in the ordinary
course of business should be given access to hard copies of the materials. Consult Legal to determine the
acceptability of using electronic communication.
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10.4.3. For less formal communications, the company can take advantage of the broad-based nature of
ESPPs by using social media such as Facebook, Twitter, and company message boards to generate interest
in the plan. When these methods are used, monitor what the employees are saying and correct any incorrect information posted. Before posting information on such sites, clear the content with Legal to determine
whether it is appropriate for legal purposes.
10.5. Issues Related to Non-US Employees.
10.5.1.While a complete discussion of global communications issues is beyond the scope of this publication, it is important to recognize that each country has its own rules governing the extent and delivery of
employee communications about stock plans. In some cases, the company will be required to translate communications into a local language. Engage legal counsel that understands the specific rules of any country
in which the ESPP is offered.
11.Financial Reporting
11.1.Overview.
11.1.1.Calculating the financial statement impact of an ESPP requires special expertise. The stock plan record-keeping system may be able to calculate the expense associated with ESPPs with common design features (e.g.,
15% discount, look-back, 12-month offering period). For plans with more
complex features, the company may need to use outside resources. Equity
Compensation may play a direct role in the detailed accounting calculations
using the stock plan record-keeping system or the department may focus
on providing ESPP and payroll data to Financial Reporting.
Generally accepted accounting principles (US GAAP) are normally
used for preparing financial statements of US-headquartered
companies. The Financial Accounting Standards Board (FASB)
establishes standards for financial accounting and reporting.
All current US GAAP has been reorganized into Accounting
Standards Codification (ASC) topics. The accounting standard that
used to be FAS 123(R) as it relates to employees is now known as
"FASB ASC Topic 718 - Stock Compensation."
The International Accounting Standards Board (IASB) establishes
International Financial Reporting Standards (IFRS) that are
required or permitted in over 100 countries. IFRS 2 addresses
the treatment of share-based payments under the international
accounting standards. Accounting for share-based payment
under US GAAP ASC 718 and IFRS 2 are similar, but not identical.
This section assumes that financial results are reported under US
GAAP/ASC 718.
11.2. Noncompensatory versus Compensatory.
11.2.1. A “noncompensatory” ESPP has no recognizable compensation
cost. For an ESPP to be considered “noncompensatory,” the plan must
satisfy the following conditions:1
• Its terms are no more favorable than those available to all holders of
the same class of stock, or the purchase discount from the market
price cannot exceed the per-share issuance costs that would be
incurred through a public offering of stock (generally assumed to be
5%). A discount of 5% or less is considered a safe-harbor discount
and does not require further justification or assessment.
Equity
compensation
professionals
should understand
the impact of the
underlying data
on the valuation
of awards, the
allocation of
expense to the
appropriate
period, and the
calculation of
EPS, regardless
of the extent of
involvement in
financial reporting.
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| financial rep orting
11.1.2.This section provides an overview of the key concepts regarding the
financial reporting for ESPP plans. In this section the term “withholdings”
will be used to indicate contributions to an ESPP made through either payroll deduction or lump sum payments. This is consistent with terminology
used in the accounting literature. The fair value of an ESPP is determined
using the component measurement approach. Each design feature of an
award is valued separately, and the respective values are added to determine the fair value of the award. These concepts apply to qualified and
nonqualified plans and to US and non-US employees. This section discusses
the most common types of ESPPs, the associated design features, and how
each component is valued. A thorough discussion of the financial reporting
requirements associated with ESPPs is outside the scope of this publication.
• Substantially all employees may participate on an equitable basis
• The plan incorporates no option-like features (e.g., a look-back), except for the following:
o Employees are permitted a period not to exceed 31 days after the purchase price has been fixed to
enroll in the plan
o The purchase price is based on the FMV of the shares on the purchase date
o Employees are permitted to withdraw from the plan and receive a refund of any amounts paid
Most ESPPs are compensatory because they either contain a look-back feature or have a discount greater than
5%. The remainder of this section describes the accounting treatment under ASC 718 for compensatory ESPPs.
11.3. Grant Date and Requisite Service Period.
11.3.1. The general definition of the grant date in ASC 718 requires a mutual understanding of the terms and
conditions of a share-based payment arrangement. Generally, the date when an ESPP offering begins is the
grant date. Treasury regulations connected with IRC §423 specify that the maximum number of shares that
an employee can purchase during an offering must be established at the offering date in order to establish a
grant date for tax purposes. This is not required to establish a grant date for financial reporting purposes.
11.3.2. The requisite service period is the period over which the employee participates in the plan and pays
for the shares. The period from the offering date through the purchase date is generally the requisite service
period. Some plans provide for overlapping offering periods with multiple purchase periods. See Exhibit 3-1,
Example 3, for an illustration of an overlapping offering period with purchases every six months.
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11.4. Fair Value and Amortization by Plan Feature.
11.4.1. The examples in FASB Technical Bulletin 97-1 (also known as FTB 97-1 and now contained in ASC
Subtopic 718-50) measure total compensation cost at the grant date based on the number of shares that
can be purchased using the estimated total withholdings and market price of the stock as of the grant date.
The cost is not adjusted for the potentially greater number of shares that may ultimately be purchased if the
market price declines.2 Rather, the possibility of value gained from a decrease in stock price is built into the
grant date fair value. No true up is required based on the final ESPP shares purchased except for terminations and changes due to compensation adjustments.
11.4.2. The fair value for a compensatory ESPP is determined as of the grant date and is recognized over
the requisite service period. Certain common plan features may be treated as modifications when they are
triggered and may lead to additional compensation expense. The fair value of an award under an ESPP with
multiple purchase periods should be determined at the grant date in the same manner as a stock option
that has graded vesting.3 See previous GPS publications for more detailed discussions of determining the
fair value of options with graded vesting.
11.4.3. The simplest type of ESPP offers a discount on the stock price on the offering date and does not
have a look-back. The fair value is essentially the discount multiplied by the grant price (assuming the stock
does not pay dividends). Since many ESPPs have features similar to options (i.e., look-backs), the calculation
of fair value frequently requires multiple components and option pricing models, including:
• A percentage of a share of stock, representing the discount provided by the Plan
• A percentage of a call option, representing the additional benefit the employee receives if the stock price
on the exercise date is higher than the stock price on the grant date
• A percentage of a put option, representing the guaranteed discount on the grant date stock price when
the stock price on the exercise date is lower than the stock price on the grant date and additional shares
are purchased
Puts and Calls
Share Option: A contract that gives the holder the right, but not the obligation, either to
purchase (to call) or to sell (to put) a certain number of shares at a predetermined price for
a specified period of time. Most share options granted to employees under share-based
arrangements are call options, but some may be put options.4
11.4.4. The call option and the put option are generally calculated using the Black-Scholes option-pricing formula. This valuation technique is used in the examples in this publication. Since the purchase or exercise date
occurs at a set and known date (i.e., the purchase date), and there is no possibility of early exercise, it is generally not required to use more sophisticated valuation techniques (e.g., binomial model or Monte Carlo simulation). The inputs are the grant date stock price, exercise price, expected life, volatility, risk-free interest rate,
and dividend yield. The stock price is equal to the FMV on the grant date, which is typically the offering date.
The price is determined according to the Plan, and may be the closing stock price on the offering date, the
closing stock price on the day prior to the offering date, or the average of the high and the low prices on the
offering date. The exercise price is generally equal to the FMV on the grant date. Note that the exercise price is
not reduced by the discount when determining the fair value for financial reporting purposes. In some limited
cases the exercise price may be different from the grant price. For example, a company may structure an ESPP
to start the same day as the company’s IPO. The exercise price for the first offering may be defined as the IPO
price, while the grant price is equal to the closing price the day of the IPO, which is likely to be different.
11.4.5. The remaining assumptions are calculated similar to those for stock option or stock appreciation right
valuations. The expected life, however, is easier to calculate for ESPPs than for options and is simply equal to
the time from the grant date to the purchase date. The volatility is generally calculated as the historical volatility over the expected life, the implied volatility, or some combination of the two. In the case of newly public
companies, peer data may be used to determine the volatility. Like stock options, there is no single prescribed
methodology for determining the volatility. The methodologies that are listed here are common ones used in
practice, but this is not meant to be an all-inclusive list. The risk-free interest rate is the rate over the expected
life. The dividend yield is the annualized yield expected to be paid over the expected life.
• Zone 1: Represents the value delivered because of the 15% discount.
• Zone 2: Represents the value delivered only when the stock appreciates above $10. This piece illustrates
the benefit of the call option from the look-back provision.
• Zone 3: Represents the value delivered only when the stock price depreciates below $10. This piece
illustrates the benefit of the put option from the look-back provision.
Since the mathematics underlying the Black-Scholes model reflect a probability distribution of the future
possible stock prices upon payout, the fair value of the call and the put options reflect the fair value depicted in Zones 2 and 3.
EXHIBIT 11-1: VALUE OF ESPP COMPONENTS
$8.00 —
Total Value of the Award
$7.00 —
Put option on 15% of a share of stock
Call option on 85% of a share of stock
$6.00 —
15% of a share of stock
$5.00 —
$4.00 —
ZONE 2
$3.00 —
$2.00 —
$1.00 —
0—
|
0
ZONE 3
|
$2.00
ZONE 1
|
$4.00
|
$6.00
|
$8.00
|
$10.00
Exercise Date Stock Price
|
$12.00
|
$14.00
|
$16.00
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| financial rep orting
11.4.6. Exhibit 11-1 illustrates the concepts of the ESPP component valuation for ESPP shares granted at
$10 and the potential payouts earned when the ultimate stock price ranges from $0 to $16. The chart is
categorized into three zones:
11.4.7. ASC 718-50 lays out the accounting treatment for common types of ESPP with a look-back feature.
A look-back establishes the purchase price as the lower of:
• The stock price on the grant date (offering date) or
• The stock price on the exercise date (purchase date)
The standard defines nine types of ESPP (Types A through I) and details the fair value treatment for each.
These are summarized in Exhibit 11-2. The fair values are determined using the component measurement
approach, which means that different plan features are valued separately and summed together. Other plan
design permutations are possible; however, this concise list covers the majority of plans.
EXHIBIT 11-2: SUMMARY OF ESPP PLAN TYPES
Type
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financial rep orting
Name
Distinction
Type A
Maximum Number of Shares
Maximum number of shares is determined on the date of
grant using the FMV at the grant date
Type B
Variable Number of Shares
When the stock price declines, the employee is able to
purchase more shares (i.e., there is no purchase price limit)
Type C
Multiple Purchase Periods
Longer look-back periods offer greater benefit to
employees
Type D
Multiple Purchase Periods with a Reset
Reset protects against stock price declines since a lookback price is reset
Type E
Multiple Purchase Periods with a Rollover
If the stock price declines, the offering is restarted at
lower price
Type F
Multiple Purchase Periods with Semifixed
Withholdings
Allows increases or decreases to future contributions for
future purchase periods within the offering period
Type G
Single Purchase Periods with Variable
Withholdings
Allows increases or decreases to future contributions at
any time
Type H
Multiple Purchase Periods with Variable
Withholdings
Allows increases or decreases to future contributions at
any time
Type I
Single Purchase Period with Variable
Withholdings and Cash Infusions
Allows increases to past contributions and increases and
decreases to future contributions at any time
11.4.8. Type A – Maximum Number of Shares.
11.4.8.1. Type A (Maximum Number of Shares) plans feature a look-back and set the maximum number
of shares an employee can purchase at the grant date. The maximum number of shares is fixed based on
the grant date price. Excess contributions are refunded if the FMV declines during the purchase period.
The employee does not purchase more shares if the stock price declines. Exhibit 11-3 illustrates the potential value of a Type A plan.
EXHIBIT 11-3: TYPE A PLAN
Plan Provisions:
Offering period
Offering price
Contribution
Inclusion of look-back
Interest paid on payroll deductions
6 months
85% of fair market value on lower of FMV on grant date or
purchase date
$1,000 total (prorata amount deducted from each paycheck)
Yes
No
Depreciating
Stock Price
Appreciating
Stock Price
$10.00
$8.00
$6.80
117.6471
$10.00
$10.00
$8.50
117.6471
$10.00
$12.00
$8.50
117.6471
Value from discounted offering price
$141.18
$176.47
$176.47
Value from look-back
$0.00
$0.00
$235.29
Total value delivered [(B - C) X D]
$141.18
$176.47
$411.76
Amount Refunded to Employee
[$1,000 – (C X D)]
$200.00
N/A
N/A
11.4.8.2. The fair value for a Type A plan consists of three components:
• Discount on a share of stock
• A portion (1 minus the discount percentage) of a call option
• Interest foregone
See Exhibit 11-4 for a summary of the fair value of the award described in Exhibit 11-3. The fair value of the
award is fixed at the date of grant. Any subsequent appreciation in the stock price requires no adjustment
to the original grant date fair value as the potential appreciation is factored into the value in the call option
component of the original calculation. The valuation impact of dividends is discussed in paragraph 11.5.2.
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| financial rep orting
Assumptions:
Stock price at beginning of offering period (A)
Stock price at end of offering period (B)
Purchase price (C=85% of lesser of A or B)
Shares purchased
[D=1,000 divided by (85% of A)]
Number of shares purchased limited based
on grant date price
Fractional shares issued
Flat
Stock Price
EXHIBIT 11-4: CALCULATION OF FAIR VALUE OF TYPE A AND B PLANS
Plan Provisions:
Offering period
Offering price
Inclusion of look-back
Interest paid on payroll deductions
56
6 months
85% of fair market value on lower of FMV
on grant date or purchase date
Yes
No
Type A Plan
Type B Plan
Assumptions:
Grant date stock price
Expected life
Volatility
Risk-free rate
Dividend yield
$10
0.50
50%
0.25%
0%
$10
0.50
50%
0.25%
0%
15% of stock price
$1.50
$1.50
85% of a call option
$1.20
$1.20
15% of a put option
N/A
$0.21
Interest foregone
-$0.01
-$0.01
Total fair value
$2.69
$2.90
11.4.9Type B – Variable Number of Shares
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|
11.4.9.1. Type B (Variable Number of Shares) plans are the same as Type A plans except that an employee may purchase as many shares as their withholdings permit. This means that when the stock price is
lower on the exercise date than on the grant date, an employee will purchase additional shares of stock
with his withholdings. Exhibit 11-5 illustrates the potential value for a Type B plan.
11.4.9.2. Any plan with a look-back feature must state whether the number of shares that can be
purchased is fixed (based on estimated contributions and the initial price) or variable. If the number of
shares is fixed at the beginning of the offering period and if the stock price subsequently declines on the
purchase date, then the employees purchase the shares up to the set limit and would receive a refund
of leftover funds. If the plan allows for variable shares, then employees can purchase additional shares
when the stock price declines, subject to any IRS or Plan limitations.
EXHIBIT 11-5: QUALIFIED PLAN WITH LOOK-BACK
Plan Provisions:
Offering period
Offering price
Contribution
Inclusion of look-back
Interest paid on payroll deductions
6 months
85% of fair market value on lower of FMV on grant date
or purchase date
$1,000 total (prorata amount deducted from each paycheck)
Yes
No
Depreciating
Stock Price
Assumptions:
Stock price at beginning of offering period (A)
Stock price at end of offering period (B)
Purchase price (C=85% of lesser of A or B)
Shares purchased (D=1,000 divided by C)
Number of shares purchased not limited by Plan
Fractional shares issued
Flat
Stock Price
Appreciating
Stock Price
$10.00
$8.00
$6.80
147.0588
$10.00
$10.00
$8.50
117.6471
$10.00
$12.00
$8.50
117.6471
Value from discounted offering price
$176.47
$176.47
$176.47
Value from look-back
$0.00
$0.00
$235.29
Total value delivered [(B - C) X D]
$176.47
$176.47
$411.76
11.4.9.3. Exhibit 11-5 illustrates an award with a guaranteed minimum value of 15% of the grant date
stock price, which in this example is $176.47. This additional feature is valued as the equivalent of a put
option on 15% of the shares with the exercise price equal to the grant price. The put option is valued
using the stock price on the grant date and is not adjusted for the discount, similar to the valuation for
the call option feature. Thus, the fair value for a Type B ESPP consists of four components:
• Discount on a share of stock
• A portion (1 minus the discount percentage) of a call option
• A portion (the discount percentage) of a put option
• Interest foregone
See Exhibit 11-4 for a summary of the fair value of the award described in Exhibit 11-5. The exhibit compares the cost of a Type A plan with a Type B plan. Note that the only difference is the inclusion of the
put option.
11.4.10. Type C – Multiple Purchase Periods
11.4.10.1. Type C (Multiple Purchase Periods) plans have the same features as Type B plans, except
that an offering period will have multiple purchase periods within a single offering. These plans set the
exercise price at the lesser of the FMV at the beginning or ending of the offering period. An employee
gets the additional benefit of a longer look-back period, since in theory the stock price has more time to
appreciate. Exhibit 11-6 illustrates this type of plan.
EXHIBIT 11-6: QUALIFIED PLAN WITH LOOK-BACK AND MULTIPLE PURCHASE DATES
Offering price
Contribution
Inclusion of look-back
Interest paid on payroll deductions
Offering period of 24 months (February 1, 2012, to January
31, 2014) with purchases every six months (July 31, 2012,
January 31, 2013, July 31, 2013, and January 31, 2014)
85% of fair market value on lower of FMV on grant date
or purchase date
$1,000 total (prorata amount deducted from each paycheck)
Yes
No
Assumptions:
FMV on February 1, 2012 (A)
FMV on July 31, 2012 (B)
FMV on January 31, 2013 (C)
$10.00
$8.00
$9.00
July 31, 2012 purchase
FMV on February 1, 2012 (A)
FMV on July 31, 2012 (B)
Lesser of 85% of lesser of A or B ($8.00 x 85%)
$10.00
$8.00
$6.80
January 31, 2013 purchase
FMV on February 1, 2012 (A)
$10.00
FMV on January 31, 2013 (C)
$9.00
Lesser of 85% of lesser of A or C ($9.00 x 85%) $7.65
11.4.10.2. The components of the fair value calculation are the same as for a Type B plan. The difference is that for a Type C plan a fair value is associated with each purchase period. The longer the
look-back period, the greater the expense. The length of the look-back period increases the call and put
option fair values and also affects the calculation of the volatility and risk-free rates. Higher volatilities
and risk-free rates also increase the call and put option fair values. In practice the volatilities and risk-free
rates may not always increase as the life increases. Exhibit 11-7 illustrates the fair value calculations for
this type of plan.
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| financial rep orting
Plan Provisions:
Offering period
EXHIBIT 11-7: VALUATION OF TYPE C PLANS
6-Months
12-Months
18-Months
24-Months
Grant date stock price
$10
$10
$10
$10
Expected life
0.50
1.00
1.50
2.00
Volatility
50%
55%
60%
63%
Risk-free rate
0.25%
0.75%
1.25%
1.5%
Dividend yield
0%
0%
0%
0%
15% of stock price
$1.50
$1.50
$1.50
$1.50
85% of a call option
$1.20
$1.87
$2.49
$3.01
15% of a put option
$0.21
$0.32
$0.41
$0.49
Interest foregone
-$0.01
-$0.03
-$0.08
-$0.13
Total fair value
$2.90
$3.66
$4.32
$4.87
11.4.11. Type D – Multiple Purchase Periods with a Reset
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11.4.11.1. Type D (Multiple Purchase Periods with a Reset) plans are similar to Type C plans, except that
they contain a “reset” feature. If the FMV on a purchase date is less than the grant date FMV, then the
reset is triggered. For the remaining purchase periods within the offering period, the look-back will be
based on the FMV as of the beginning of the purchase period immediately following the date when the
reset is triggered (typically one day after) and the FMV on the exercise date.
11.4.11.2. At the grant date, the fair values of the tranches are calculated, the same way as for a Type
C plan. The expense is amortized over the purchase periods in accordance with the company’s policy for
straight-line or graded amortization. Some practitioners refer to this as “FIN 28”, front-loaded amortization, or accelerated amortization. Straight-line amortization spreads the expense evenly from the grant
date to the last vesting date (for an ESPP this would be the last purchase date in an offering period).
Graded amortization treats each tranche as a separate and standalone award, such that the expense associated with each tranche is recognized from the grant date to the vesting date of the tranche.
11.4.11.3. When the FMV is lower on an exercise date than on the grant date, the employees will purchase shares for the current purchase period based on the discounted exercise price. There is no change
to the fair value calculations for this period or prior periods. However, for any future purchase periods
remaining in the offering period, the reset feature triggers modification accounting under ASC 718. The
modification occurs because the employees are, in essence, exchanging an option to purchase shares at
the grant date price for an option to purchase shares at a new lower stock price. This additional benefit
results in additional expense for the company. The modification expense is based on two components:
• Incremental expense calculated on the date of the modification based on the excess of the fair
value immediately after the modification when compared to the fair value immediately before the
modification
• Additional shares that an employee will be able to purchase based on the decrease in stock price (i.e.,
new look-back FMV), as compared to the estimated shares calculated on the grant date
Any additional expense resulting from the modification will be amortized over the remaining purchase
periods. These concepts are illustrated in Exhibits 11-8 and 11-9.
EXHIBIT 11-8: VALUATION OF TYPE D PLANS
Plan Provisions:
Offering period
Dividends
Interest paid on payroll deductions
Contribution
Reset
Offering period of 24 months (January 1, 2012, to December
31, 2013) with purchases every six months (June 30, 2012;
December 31, 2012; June 30,2013; and December 31, 2013)
None
No
$850 each purchase period
Yes; triggered on June 30, 2012
12/31/2012
6/30/2013
12/31/2013
$10
$10
$10
Grant date exercise price
$8.50
$8.50
$8.50
Price on July 1, 2012
$8
$8
$8
Exercise price on July 1, 2012
$6.80
$6.80
$6.80
Expected life
0.50
1.00
1.50
Volatility
50%
55%
60%
Risk-free rate
0.25%
0.75%
1.25%
Dividend yield
0%
0%
0%
15% of stock price
$1.20
$1.20
$1.20
85% of a call option
$0.43
$0.95
$1.48
15% of a put option
$0.37
$0.46
$0.53
Present value of interest foregone
-$0.01
-$0.03
-$0.08
Total pre-modification fair value
$1.99
$2.58
$3.13
15% of stock price
$1.20
$1.20
$1.20
85% of a call option
$0.96
$1.49
$2.00
15% of a put option
$0.17
$0.25
$0.33
Present value of interest foregone
-$0.00
-$0.03
-$0.06
Total post-modification fair value
$2.33
$2.91
$3.47
Pre-modification fair value:
Post-modification fair value:
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| financial rep orting
Grant date stock price
EXHIBIT 11-9: MODIFICATION EXPENSE RELATED TO TYPE D PLANS
After the reset, the total expense for the offering period is calculated as follows and amortized over the
remaining purchase periods.
6/30/2012
12/31/2012
6/30/2013
12/31/2013
Grant date stock price
$10
$10
$10
$10
Grant date share estimate (A=$850/$8.50)
100
100
100
100
Grant date fair value from Exhibit 11-6 (B)
$2.90
$3.66
$4.32
$4.87
Total grant date expense (C=A X B)
$290
$366
$432
$487
Pre-modification shares (D=$850/$8.50)
N/A
100
100
100
Pre-modification fair value from Exhibit
11-7 (E)
N/A
$1.99
$2.58
$3.13
Pre-modification expense (F=D X E)
N/A
$199
$258
$313
Post-modification shares (G=$850/$6.80)
N/A
125
125
125
Post-modification fair value from Exhibit
11-7 (H)
N/A
$2.33
$2.91
$3.47
Post-modification expense (J=G X H)
N/A
$291
$361
$434
Total modification expense (K=J - F)
N/A
$92
$103
$121
Total expense (C + K)
$290
$458
$535
$608
Modification expense:
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11.4.12. Type E – Multiple Purchase Periods with a Rollover
11.4.12.1. Type E (Multiple Purchase Periods with a Rollover) plans are similar to Type D plans, except
that instead of a reset feature, they contain a rollover feature. A rollover occurs when the stock price on
an exercise date is lower than the grant date stock price. At the rollover, the offering period is cancelled
immediately after the purchase date and the employees are “rolled over” into a new offering period that
uses the lower stock price as the base price.
11.4.12.2. If Exhibits 11-8 and 11-9 are applied to a Type E rollover plan, the incremental modification
expense is similar. The expense for the first three purchase periods is the same. The expense associated
with an additional purchase period must be added for plans with a rollover. No expense is associated
with this additional purchase period from the previous offering period; therefore, there is no pre-modification expense and the fair value is the full amount of the post-modification fair value.
11.4.12.3. From administrative, accounting, and tax perspectives, reset and rollover features create
complications. Tracking these changes is especially challenging because the features can be triggered
multiple times within an offering. Ensuring that the $25,000 limit on qualified plans and plan share limits
are applied appropriately when estimating expense (as well as when administering the actual purchase)
is challenging since resets and rollovers allow for the purchase of additional shares each time they are
triggered.
11.4.13. Type F – Multiple Purchase Periods with Semifixed Withholdings
11.4.13.1. Type F (Multiple Purchase Periods with Semifixed Withholdings) plans are similar to Type C
plans (multiple purchase periods) except that an employee can increase or decrease his or her withholding amount immediately after a purchase period begins, to be effective for all future purchase periods
in the offering. In practice, the employee authorizes a change for future purchase periods during the
current period, but the change is not effective until the new purchase period.
11.4.13.2. Like Type D and Type E plans, Type F plans can trigger modification accounting under ASC
718. Any time an employee increases withholdings, modification accounting is triggered. For Type
F plans, all increases are effective at the start of each new purchase period. Any decreases in withholding elections are ignored for expense purposes (i.e., the expense is not decreased to reflect this
change because this is, in substance, a decision not to exercise). Decreases in withholdings, including decreases to 0%, are comparable to the cancellation (not to be confused with a “forfeiture”) of
vested employee stock options under ASC 718 in that there is no reversal of expense for these occurrences. The incremental modification is calculated based on the pre- and post-modification expense.
The total modification expense will be equal to the modification fair value multiplied by the additional
shares able to be purchased.
11.4.14. Type G – Single Purchase Periods with Variable Withholdings
11.4.14.2. Each time an employee increases his withholding election, modification accounting is triggered. The modification expense is calculated the same as for a Type F plan, where the additional cost
is the number of incremental shares now able to be purchased multiplied by the modification date
fair value. Variable withholdings add complexity to a plan because a modification valuation is required
each time an employee increases withholdings, which could occur on numerous days during a purchase period. Thus, multiple fair values must be calculated, audited, and amortized over the remaining
purchase period. Decreases in withholdings do not result in any modification accounting and any previously recorded expense for these “cancelled” shares is not reversed. These concepts are illustrated in
Exhibit 11-10.
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11.4.14.1. Type G (Single Purchase Periods with Variable Withholdings) plans allow employees to
change their withholdings at any time during the purchase period. The employee can increase or decrease the election for the purpose of all future withholdings. This type of plan can be combined with
Type A or B plans, which are both single purchase period plans. A plan can allow unlimited contribution
changes or place a limit on the number of changes permitted during the period.
EXHIBIT 11-10: VALUATION OF TYPE G PLANS
Plan Provisions:
Offering period
Dividends
Interest paid on payroll deductions
Contribution
6 months, beginning January 1, 2012
None
No
$850 each purchase period
Assumptions:
FMV on grant date
Grant date fair value from Exhibit 11-4
Employee increased contributions on April 1, 2012
FMV of stock on April 1, 2012
$10
$2.90
$1,850 (a $1,000 increase per purchase period)
$12
The fair value for the modification is calculated as follows:
62
Pre-Modification
Post-Modification
$10
$10
Grant date exercise price
$8.50
$8.50
Price on 4/1/2012
$12
$12
Expected life
0.25
0.25
Volatility
45%
45%
Risk-free rate
0.15%
0.15%
Dividend yield
0%
0%
15% of stock price
$1.80
$1.80
85% of a call option
$1.95
$1.95
15% of a put option
$0.04
$0.04
Present value of interest foregone
-$0.00
-$0.00
Total modification fair value
$3.79
$3.79
Shares to be purchased
100
217.6471
Pre- and post-modification expense
$379
$825
Incremental expense (post-modification minus premodification)
$446
financial rep orting
|
Grant date stock price
The pre- and post-modification fair values are equal because the pre- and post-modification assumptions are the same. The only
change is to the number of shares the employee will purchase. The modification expense is equal to the fair value multiplied by
the incremental number of shares able to be purchased. In this case, the employee can purchase an additional 117.6471 shares
($1,000/$8.50), so the total modification expense is $446 (117.6471 shares X $3.79 fair value). The total expense for this employee is
$936 ($290 grant date expense plus $446 modification expense).
11.4.15. Type H – Multiple Purchase Periods with Variable Withholdings
11.4.15.1. Type H (Multiple Purchase Periods with Variable Withholdings) plans combine Type C (multiple purchase periods) and Type G plans (variable withholdings). As with Type G plans, modification
accounting is triggered when employees increase withholding elections.
11.4.15.2. Perhaps the most complex type of plan seen in practice combines Type E (rollover), Type F
(multiple purchase periods with semifixed withholdings), and Type H (variable withholdings). All three
plan types can trigger modifications that must be tracked and accounted for separately. The complexities
of multiple modifications include:
• Offering periods can roll over multiple times, and then incremental share calculations must be tracked
separately.
• A rollover and an increase in contribution under a Type F plan (where the increase is effective for
future purchase periods) can occur concurrently and trigger modification accounting on the same
date. Issues arise regarding which incremental change is calculated first and which incremental shares
are associated with which fair values.
• A rollover and increases under Type F and Type H plans (where contributions are increased during a
current purchase period) can occur. Tracking the appropriate fair values and incremental shares able to
be purchased due to each modification is difficult.
In addition for any type of modification, plan and IRS share limits cannot be exceeded.
11.4.16. Type I – Single Purchase Period with Variable Withholdings and Cash Infusions
11.4.16.1. Type I (Single Purchase Period with Variable Withholdings and Cash Infusions) plans are
similar to Type G plans (single purchase period with variable withholdings) except that if an employee
chooses to increase his withholdings, the “catch up” amounts can be paid at any point during the purchase period. The result is as if the employee chose to contribute at the higher contribution level for the
entire purchase period.
11.4.17. Plans can combine features of different types of plans. For example, a plan that combines Type
E (rollover), Type F (multiple purchase periods with semifixed withholdings), and Type H (variable withholdings) is a very rich yet complex plan. It provides a great deal of flexibility for employees since they can
change contributions throughout the offering (although some plans limit the number of changes) and the
look-back and rollover feature protects them from stock price declines. From an administrative and financial reporting perspective, this type of plan can be burdensome to track and account for appropriately.
11.5 Other Considerations.
11.5.1Foregone Interest.
11.5.1.1. The examples in ASC 718 do not consider the effect of interest foregone by the employee
on the fair value of an award. Most ESPPs do not pay interest on the payroll withholdings collected
from employees. The fair value should be reduced for the effect of foregone interest. Many companies
exclude this component in the valuation as the difference is immaterial, but it is technically correct to
include in the fair value calculation. Local law may require interest be paid on contributions by non-US
employees. In certain cases contributions may be made by lump-sum payment rather than payroll deduction. The timing of the lump-sum payment could affect the calculation of foregone interest. Foregone interest is a product of the following components:
• FMV of the stock on the grant date
• Length of the purchase period
• Annualized risk-free rate of return
• 0.5 (assuming payroll withholdings are collected evenly over the purchase period and interest is paid at
the midpoint of the period)
• Present value factor:
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11.4.16.2. Since there may not be a mutual understanding of the terms of the award, the grant date
may not be determined until just before the exercise date. For example, assume an employee elected to
withhold 1% of his compensation at the beginning of the offering period. One week before the purchase, the employee elects to make a catch-up contribution equal to contributing 15% of his compensation over the whole period. In this case, the grant date is the date the employee makes the catch-up
contribution. There is no modification because the 15% election pertains to past services rendered. If
the initial election is de minimis, the final measurement of the award may be deferred until the grant
date is determined.
11.5.2Present Value of Dividends.
11.5.2.1. For dividend-paying shares, the fair value must be adjusted if dividends are not paid on unvested shares of stock. Frequently dividends are not paid until the shares are purchased. The values of
the unvested stock and the option components (and put, if applicable) are adjusted to account for the
dividends employees do not receive during the purchase period.5
11.5.2.2. The components of the fair value for a Type B ESPP are as follows:
• Discount on a share of stock multiplied by the present value factor
• The present value factor assumes that dividend payments are reinvested in the stock and the present
value of one share of stock that does not receive dividends is less than one:
• Call option (with an annualized dividend yield assumption) multiplied by one minus the discount
• Put option (with an annualized dividend yield assumption) multiplied by the discount
• Present value of interest foregone
Exhibit 11-11 summarizes the impact of dividends on the valuation.
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financial rep orting
EXHIBIT 11-11: IMPACT OF DIVIDENDS ON THE VALUATION
Plan Provisions:
Offering period
Offering price
Dividend payment
Inclusion of look-back
Interest paid on payroll deductions
6 months
85% of fair market value on lower of FMV on grant date or purchase date
$0.25 per quarter, which is 2% annually
Yes
No
No Dividends Paid on
Unvested Shares
Assumptions:
Dividends Paid on
Unvested Shares
Grant date stock price
$10
$10
Expected life
0.50
0.50
Volatility
50%
50%
Risk-free rate
0.25%
0.25%
Dividend yield
2%
0%
Present value factor of 1 share of stock 99.01%
100%
15% of stock price X present value
factor
$1.49
$1.50
85% of a call option
$1.15
$1.20
15% of a put option
$0.22
$0.21
Present value of interest foregone
-$0.01
-$0.01
Total fair value
$2.85
$2.90
11.5.3Treatment of Compensation Increases.
11.5.3.1 Changes in withholdings due to compensation increases are not considered modifications
to the awards. ASC 718 includes commissions and bonus payments in the definition of compensation
increases. Additional compensation expense will be recorded based on the incremental number of shares
purchased with the additional amounts withheld multiplied by the grant date fair value. The incremental
number of shares is calculated based upon the exercise price on the grant date, as if the calculation were
performed on the grant date. Some companies include expected compensation increases in the initial
grant date estimates to minimize adjustments to the compensation expense at the end of the period.
11.5.4Terminations versus Withdrawals.
11.5.4.1. ASC 718 makes a distinction between terminations and withdrawals from a plan. A termination
is considered a pre-vesting forfeiture. Previously recognized expense for the purchase is reversed and no
further expense is recognized, similar to a stock option that is forfeited prior to vesting. A withdrawal occurs
when an employee decreases his or her contribution to $0 (or 0%) and obtains a refund of any amounts
previously contributed during the purchase period. When a withdrawal occurs, the grant date expense associated with the shares is not reversed. The withdrawal is ignored for accounting purposes, which is similar to
the accounting treatment of a cancellation of an employee stock option (i.e., the requisite service period has
been satisfied and the employee is simply choosing not to “exercise” the “option” to purchase the shares).
11.5.4.2. The treatment of a withdrawal is further complicated when a plan contains a reset or rollover
feature. If an employee withdraws prior to a reset or rollover occurring, then no incremental expense associated with the award is recorded since no additional benefit is realized by the employee.
11.5.5 Tax Accounting.
11.5.5.2. An additional paid-in capital (APIC) pool is established to track the cumulative effects of the
actual corporate tax benefit as compared to the estimated benefit. It is treated as a “memo account”
and is not recorded as capital of the Company. If the estimated corporate tax benefit exceeds the deduction on the corporate tax return, the different is offset against the APIC pool balance until the balance
of the APIC pool is zero. (The APIC pool can never be negative.) If the APIC pool has a zero balance and
the estimated corporate tax benefit exceeds the deduction on the corporate tax return, the difference
increases tax expense that is charged to current period earnings. If the deduction on the corporate tax
return exceeds the initial estimated benefit, the APIC pool is increased to the extent a benefit was realized by a reduction in corporate tax. A complete discussion of the rules regarding the APIC pool calculations, complexities, and accounting policies/elections is beyond the scope of this publication.
11.5.5.3 For qualified ESPPs, the potential tax benefit is not tracked as a DTA. If the employee engages in a
disqualifying disposition, the amount that would have been estimated is compared to the actual tax benefit.
If the actual tax benefit is greater than the estimate, the estimate (which is the compensation cost multiplied
by the corporate tax rate) reduces the company's income tax expense and the excess is treated as APIC. If
the actual tax benefit is less than the estimate, the tax expense is reduced by the actual tax benefit.
11.5.6.Diluted EPS.
11.5.6.1. Shares issued under ESPPs are outstanding shares and are included in the calculation of basic
and diluted earnings per share (EPS). The treatment of unvested ESPP shares in calculating EPS is unclear
since Footnote 1 of FTB 97-1 states that they are treated as contingently issuable shares under ASC 260,
but this footnote was not included in the codified standard.
11.5.6.2. If a company follows the contingently issuable approach, the contingency is the employees’
payroll withholdings through the end of the period. The unvested shares that are expected to be purchased with these withholdings are calculated and one of two methods is applied:
• If withholdings are refundable, the treasury stock method is applied to the unvested ESPP shares, just
like unvested employee stock options and shares. This is the most common method used in practice.
• If withholdings are nonrefundable and a contingently issuable ESPP share is expected to vest, then the
full amount of the ESPP share is included in the diluted EPS calculation.
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11.5.5.1. The value of equity compensation to be expensed should consider the potential tax benefit of a
corporate tax deduction. The benefits of the corporate tax deduction are recognized currently for financial reporting purposes provided the cumulative amount of compensation cost recognized for equity compensation ordinarily would result in a future tax deduction under existing tax law.6 Since tax deductions
for qualified plans are limited to disqualifying dispositions, no corporate tax benefit can be anticipated.
Corporate tax deductions can be estimated for nonqualified plans and offset the financial reporting cost
of nonqualified plans. The potential tax benefits for nonqualifed plans are tracked as a deferred tax asset
(DTA) (i.e., a tax deduction will be claimed on the actual corporate tax return in the future). When actual
tax benefits are claimed (normally when the purchase occurs for nonqualified plans), a tax deduction is
permitted for the amount the employee reports as taxable income assuming the compensation qualifies
as a deduction. The actual benefit when the deduction is claimed on the corporate tax return most likely
will not be equal to the estimated benefit initially recorded for financial reporting purposes.
11.5.6.3. Another approach applies the treasury stock method to the unvested shares for the entire
purchase period, not just the portion for which withholdings have been collected through the end of the
period. This method assumes that the unvested ESPP shares are not contingently issuable.
11.6 Sensitivity of Valuation Assumptions.
11.6.1. When designing a plan, the employee benefit must be weighed against the financial reporting
impact. The financial impact of each design feature may not be intuitive and financial modeling may be
appropriate as design features are considered. Exhibit 11-12 illustrates the fair value as a percentage of the
grant price for ESPPs with various look-back periods and volatilities, assuming a 15% discount, no dividends,
no interest paid on payroll deductions, and a risk-free rate of 1.5%. A more complicated plan has more
variables and the ultimate cost is more difficult to forecast.
2 Years
1 Year
6 Months
|
financial rep orting
50% Volitility
3 Months
66
30% Volitility
No
Look-back
Cumulative Fair Value as a % of Grant
EXHIBIT 11-12: FINANCIAL REPORTING IMPACT OF ESPP FEATURES
70% Volitility
Look-Back Period
11.7 Share Limitations and the Effect on the Valuation.
11.7.1. Share limits in a plan lower the fair value of the award. As the price of a stock declines, share limits
are more likely to limit the number of shares an employee may purchase. The lower the share limit as compared to the price of the award, the more likely the share limit will be reached during a period.
11.7.2.In situations where employees are likely to reach the share limit during a period, a more sophisticated modeling technique like a Monte Carlo simulation may be necessary to value the put option component. This type of modeling is required to consider the various stock price thresholds where employees
could reach the share limit. The put option fair value is reduced based on the probabilities of reaching those
stock price thresholds. Although not technically correct, some companies in lieu of using a Monte Carlo
simulation, continue to use a Black-Scholes valuation model and adjust estimated withholdings to reflect the
effect of a potential decrease in share price on the share limit. The difference in values generated by each
model may be immaterial.
Footnotes
ASC 718-50-25-1
ASC 718-50-55-25
3
ASC 718-50-55-26.
4
Glossary ASC Topic 718.
5
ASC 718-50-55-18 and 718-50-55-19
6
ASC 718-740-25-2
1
2
Appendix A – Acknowledgements
The Certified Equity Professional Institute (CEPI) at Santa Clara University would like to acknowledge the substantial contributions that made this publication possible. Significant support was provided by our Title sponsors, Bank of America Merrill Lynch, Computershare, E*TRADE Corporate Services, Fidelity Stock Plan Services,
Morgan Stanley Smith Barney, and Radford. These leading firms have generously underwritten the major costs
associated with this project. Additional support was provided by our Contributing sponsors, Baker & McKenzie
LLP, Deloitte Tax LLP, Ernst & Young LLP, and Equity Methods. By sponsoring this research project, these industry leaders have made it possible for all issuers and service providers to benefit from comprehensive standardized industry guidelines. It is not possible to complete a project of this magnitude alone. Such an undertaking
requires the perspectives and inputs of a diverse group of industry experts. This publication is the culmination
of extensive interviews, in-depth analysis and a widespread technical review. The guidance and inputs of members of the Technical Oversight Board provided invaluable expertise throughout the project to ensure that the
publication captures an industry-wide perspective.
Technical Oversight Board
Cara Abdulrazak, Fidelity Stock Plan Services
Scott Barrall, CEP, Deloitte Tax LLP
Patricia (Trish) Boepple, CEP, Global Shares
Emily Cervino, CEP, Certified Equity Professional Institute
Valerie Diamond, Baker & McKenzie LLP
Phyllis Garland, CEP, Computershare
Cathy Goonetilleke, Ernst & Young LLP
Wendy Jennings, CEP, Riverbed Technologies, Inc.
David Lanka, CEP, Bank of America Merrill Lynch
Takis Makridis, Equity Methods
Barbara Richely, CEP, E*TRADE Corporate Services
Elizabeth Stoudt, CEP, Radford, an Aon Hewitt Company
Laura Thatcher, Alston + Bird, LLP
Kathleen Wetzel, Morgan Stanley Smith Barney
The CEPI would like to acknowledge Carol Rutlen for her vision and significant contributions in making this
project a reality. As a long-time supporter of the CEPI, previous Chair of the Advisory Board, former partner
with PricewaterhouseCoopers, and adjunct professor at San Jose State, Carol’s extensive industry experience
equipped her well for this project. As Project Leader for this publication and previous GPS publications, Carol
has been instrumental in researching and drafting this publication.
The CEPI would also like to acknowledge the substantial contributions of Elizabeth Stoudt, CEP, and Terry Adamson, CEP, of Radford, an Aon Hewitt Company. As Assistant Vice President with Radford Valuation Services,
Elizabeth is an expert at valuing ESPPs under ASC 718, and her extensive experience with financial reporting and valuation enabled her to translate the complex and confusing components of financial reporting into
detailed examples and illustrations to provide a practical “how-to-guide” in the Financial Reporting section.
As National Practice Leader for Aon’s employee equity consulting practice, Terry is involved with all phases of
equity compensation and provided sound advice and input on this project.
Recognition is also due to Valerie Diamond, Partner, Baker & McKenzie, and Andrew Schwartz, CEP, Vice President, BNY Mellon. Valerie went well above and beyond in providing meaningful and relevant input on non-US
issues. Andrew was instrumental in translating cost basis issues.
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| appendix
Elizabeth Dodge, CEP, Stock & Option Solutions
Finally, the CEPI would like to recognize Emily Cervino, CEP, Executive Director of the CEPI, for her commitment
to the CEP program and her unwavering dedication to the GPS research projects. Without her support and
involvement, the GPS research would not exist.
As an independent, academic organization the CEPI is proud to respond to the needs of the equity compensation industry by providing guidance on employee stock purchase plans.
Additionally, the CEPI is fortunate to have a dedicated and supportive Advisory Board. The Advisory Board
initially recommended that the CEPI pursue independent research projects, and the Advisory Board has been
actively involved throughout the project.
2012 Advisory Board
Matt Roberts, CEP, Chair, Fidelity Stock Plan Services
Terry Adamson, CEP, Radford, an Aon Hewitt Company
Barbara Baksa, CEP, NASPP
Patricia Boepple, Global Shares
Emily Cervino, CEP, CEPI, Santa Clara University
Tyler Clements, CEP, Accenture Ltd
Valerie Diamond, Baker & McKenzie LLP
Jennifer George, Orrick, Herrington & Sutcliffe LLP
appendix
AmyLynn Flood, PWC LLP
|
68
John Hammond, CEP, AST Equity Plan Solutions
James Hocking, CEP, Solium Transcentive
James Humza, Bank of America Merrill Lynch
Wendy Jennings, CEP, Riverbed Technology, Inc.
Ginny Johnston, E*TRADE Financial
Suzanne Luttman, Accounting Department, SCU
Takis Makridis, Equity Methods
Bill Murphy, CEP, Ernst & Young LLP
Karen Needham, CEP, Charles Schwab & Co., Inc.
Donald Polden, Santa Clara University
Vanessa Renna, CEP, Amgen
Larry Robertson, Executive Development, SCU
Loren Rodgers, NCEO
Rive Rutke Deloitte Tax, LLP
Darrin Short, CEP, Equinix
Kurt Bremer, Morgan Stanley Smith Barney
Jule Torre, Applied Materials, Inc.
Emily VanHoorickx, CEP, UBS Financial Services
Marlene Zobayan, CEP, Rutlen Associates LLC
Appendix B – Glossary
Accounting Standards Codification topic on stock compensation; incorporates
FAS 123(R)
Blackout Period
Period of time during which designated individuals cannot trade securities of a
corporation
Board
Board of Directors
Book Entry
Electronic recording of stock ownership where no physical certificate is given to
securities broker
Broker
Brokerage firm; securities dealer; registered broker; stock broker
Call Option
Used in valuing ESPP shares; an option that allows investors to buy a certain
number of shares of stock at a specified price at a specified time
Common Stock
Capital stock; securities
Compensation Expense
Expense; compensation cost
Compensatory
An ESPP that must be expensed under ASC 718
Disqualifying
Disposition
For purposes of stock purchased under an IRC §423 plan, a disposition made
within two years from grant (offering date) or one year from exercise (purchase
date)
Employee Trading
Restrictions
Restrictions for employees on trading company stock
Enrollment Date
First date of the offering; Frequently the date the right to purchase the shares is
granted
Enrollment Period
Period of time when the employee can enroll in the ESPP
Exchange Control
Restrictions on inbound and outbound transfer of local currency
Exercise
To execute the rights of an option to purchase shares at a predetermined price
Exercise Date
The date on which an option (purchase right) is exercised (purchased)
Fair Market Value
FMV
Fair Value
For accounting purposes, the value of an option (purchase right) determined in
accor¬dance with ASC 718
FAS 123(R)
Statement of Financial Accounting Standards No. 123 (revised 2004)
Form 3922
IRS form entitled “Transfer of Stock Acquired Through An Employee Stock Purchase Plan Under Section 423(c)”
FTB 97-1
FASB Technical Bulletin No. 97-1
Full-Service Brokerage
Account
A brokerage account with stock plan and normal brokerage and investment
functionality
Grant Date
Date of grant; under an IRC §423 plan, also known as offering date
Insider
A person with or eligible to have material, non-public information
Interest Foregone
Accounting term; interest is not paid on employee contributions to an ESPP,
therefore the employee is considered to have foregone interest
IRC
Internal Revenue Code
Limited-Purpose
Brokerage Account
A brokerage account that only holds shares received from equity compensation
plans (e.g., stock option, ESPP, etc.); usually established by the company for the
employees
Look-Back
A feature that bases the purchase price on the lower of the FMV on the grant
(offering) date or the exercise (purchase) date
Modification
A change to the terms of the award; an accounting term
69
| appendix
ASC Topic 718
70
appendix
|
Noncompensatory
An ESPP that has no compensation expense associated with it; plan must meet
requirements in ASC 718
Nonqualifed plan
An ESPP that is not qualified under IRC §423
Offering Date
Date of grant; under an IRC §423 plan, also known as grant date
Offering Period
The period starting with the grant (offering) date and ending with the exercise
(purchase) date
Omnibus Account
A brokerage or transfer agent account in which the assets of more than one
person are comingled; the account is managed by a custodian
Option
The right to purchase stock
Ordinary income
Compensation income; compensation
Participant
An employee participating in the employee stock purchase plan
Plan
Employee stock purchase plan
Purchase Date
For purposes of ESPPs, the date on which an option (purchase right) is exercised
(purchased)
Purchase Discount
Difference between the FMV at purchase and the purchase price
Purchase Price
Price paid for shares; the exercise price
Put Option
Used in valuing ESPP; an option that allows investors to sell a certain number of
shares of stock at a specified price at a specified time
Qualified Plan
An ESPP that meets the requirements of IRC §423
Quick Sale
Immediate sale of shares purchased; election to sell is made at the time of enrollment and sale requires no further instructions from the employee
Reset
For an offering with multiple purchase periods, if the stock price on a purchase
date is less than the grant date price, the look-back for the remaining purchase
periods will be based on the lower price
Rollover
For an offering with multiple purchase periods; if the stock price on a purchase
date is less than the grant date price, the offering is terminated and a new offering begins
Sell-to-Cover
Shares sold from award to cover tax obligations
Share Reserves
The pool of shares that has been authorized for issuance under a stock plan;
share pool
Shares
Stock
Stock Plan Brokerage
Account
Brokerage account established specifically for company stock plan transactions;
also known as a Limited-Purpose Brokerage Account
Tax Withholding
Withholding of income and social tax
Variable Withholdings
Accounting term; an employee can change the amount of contributions during
an offering period
Withdrawal
An employee election to terminate participation before shares are purchased
and accumulated contributions are refunded
Withhold-to-Cover
Shares withheld from award to cover tax obligation; net settlement
Withholding
Accounting term; employee contribution to an ESPP in the form of payroll deductions or lump-sum payments
About Our Sponsors
The Certified Equity Professional Institute (CEPI) at Santa Clara University would like to acknowledge our Title
sponsors, Bank of America Merrill Lynch, Computershare, E*TRADE Corporate Services, Fidelity Stock Plan
Services, Morgan Stanley Smith Barney, and Radford, and our contributing sponsors, Baker & McKenzie LLP,
Deloitte Tax LLP, Ernst & Young LLP, and Equity Methods for their significant contributions that made this publication possible. By sponsoring this research project, these industry leaders have made it possible for all issuers
and third party service providers to benefit from comprehensive guidelines for employee stock purchase plans.
Title Sponsors
Bank of America Merrill Lynch
At Bank of America Merrill Lynch, we know the value an equity compensation plan can have for your company and your employees, and we understand everything that’s at stake.
We believe no other company is equipped like Bank of America Merrill Lynch to deliver a more comprehensive and truly flexible equity compensation solution. Our extensive knowledge and integrated products and
services make it simple for you to implement and manage your plan, allowing you to create an ownership
culture where employees feel even more appreciated and invested in the success of the enterprise.
We offer corporations an array of integrated benefit plan solutions, including equity compensation and executive services, nonqualified deferred compensation programs, defined contribution and defined benefits plans.
baml.com/equityawards
Computershare
Computershare is a global market leader in transfer agency, employee equity plans, proxy solicitation,
stakeholder communications, and other diversified financial and governance services. Many of the world’s
leading organizations use Computershare’s services to help maximize the value of relationships with their
investors, employees, creditors, members and customers.
With Computershare’s employee stock plan outsourcing solutions, you and your employees can enjoy the
benefits of an ESPP without the challenges associated with plan administration. Your employees will appreciate the ease of plan enrollment and transactions and you will benefit from plan administration handled
by experts whose main objective is to provide you and your employees with exceptional service. When you
partner with Computershare for your ESPP administration, Computershare will support your business with a
dedicated service team and your participants with superior account management solutions.
www.computershare.com
E*TRADE Corporate Services
E*TRADE Corporate Services leads the industry as the most respected provider of innovative equity compensation solutions. With over 25 years of experience, we have a proven track record of helping companies
stay ahead of the ever-changing regulatory environment. Our powerful Equity Edge® platform provides
end-to-end administration and on-demand reporting support for all equity vehicles. From consulting to
one-to-one service, we provide you with a flexible solution to meet your company’s unique needs.
Through E*TRADE Securities, we provide a seamless experience for more than 1 million participants worldwide, with premium support for your insiders and executive team. Complete integration between Equity Edge
and etrade.com means that your participants can access up-to-date stock plan data anywhere, at any time.
Today, it’s more important than ever to successfully navigate the complex world of equity compensation.
Over 1,000 companies -- including 20% of the S&P 500 -- rely on us. Shouldn’t you be one of them?
E*TRADE Corporate Services, 4005 Windward Plaza Drive, Alpharetta, GA 30005, 1-800-783-3388
www.etrade.com/corporateservices
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| About our sponsors
Bank of America Merrill Lynch is a marketing name for the Retirement Services business of Bank of America Corporation (“BAC”).
Banking and fiduciary activities are performed by wholly owned banking affiliates of BAC, including Bank of America, N.A., member
FDIC. Brokerage services are performed by wholly owned brokerage affiliates of BAC, including Merrill Lynch, Pierce, Fenner & Smith
Incorporated (“MLPF&S”), a registered broker-dealer and member SIPC.
Investment products: Are Not FDIC Insured • Are Not Bank Guaranteed • May Lose Value
ARG6I0Q1
Title Sponsors continued
Fidelity Investments®
For more than 25 years, benefits outsourcing has been a core business for Fidelity. Today, we are one of the
leading providers of stock plan services; providing recordkeeping and administrative services to some of the
nation’s largest and most complex equity compensation plans.
You can have all the advantages of a comprehensive and expertly administered stock plan—with far
fewer worries about data integrity, systems compatibility, or the need to continually implement software
upgrades. Our seamless end-to-end process (with built-in audit control) continues to provide quality plan
administrative services that helps keep your plan moving in the right direction.
Only Fidelity provides seamless integration across different equity award types, as well as across multiple
benefits programs, for both U.S. and global plans. And to help you address your regulatory duties with confidence we provide best-in-class products, unqualified SAS 70-certified proprietary platform, and hands-on
business experience.
The more effective your stock plan, the greater its impact on the financial success, satisfaction, allegiance,
and retention of your employees. Fidelity’s guidance and planning resources—including our comprehensive
Web tool, NetBenefits®— make equity awards a natural extension of a larger financial strategy. It’s an approach proven to inspire buy-in and action among employees at all levels.
531710.2.0 | Fidelity Stock Plan Services
|
Morgan Stanley Smith Barney
About our sponsors
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http://Fidelity.com/workplace
Morgan Stanley Smith Barney is dedicated to delivering sophisticated, premier services to our corporate
clients. Whether it’s equity compensation plans, corporate retirement plans, executive advisory services, or
cash management services, we are as committed as ever to this business—and to continue to be a strong
and client-focused firm.
For nearly 40 years, we have been an industry-leading provider of global stock plan services, providing a
vast range of services to nearly 500 corporate clients and managing their 1,100 equity compensation plans
worldwide.
We offer a wide range of products and services to meet our clients’ equity plan needs. Morgan Stanley
Smith Barney provides a comprehensive, integrated administration and brokerage solution for share option,
employee stock purchase, and restricted stock and performance-based share awards. If you prefer to retain
administration in-house, we can provide a link between your share plan database and our trading systems.
Your employees benefit from multiple points of access via our online portal, Benefit Access and our multilingual Global Customer Services Centers on three continents. Our feature-rich technology platform provides a menu of widely used reports as well as an easy-to-use ad hoc reporting tool. You and your employees both reap the benefit of our focus on delivering service excellence.
www.corporateclientgroup.com
Radford, an Aon Hewitt Company
Radford is the industry leader in compensation market intelligence and compensation strategy consulting
for the technology and life sciences industries. Comprised of industry thought leaders, Radford’s global
consulting practice focuses on the compensation issues facing technology and life sciences companies at all
stages of development. For more details on our services and our consultants, visit our Consulting Overview
or e-mail [email protected].
The Radford team has a mastery of the development of required assumptions as prescribed under Topic 718
for traditional stock options in any option pricing model, as well as alternative modeling approaches that
better approximates compensation expense, and exotic models required to calculate performance awards.
Working with 300-plus companies, including 50 Fortune 500 companies, Radford has the experience and
depth to help your organization comply with Topic 718.
www.radford.com/valuationservices
Contributing Sponsors
Baker & McKenzie LLP
Baker &McKenzie - the industry leader in global equity solutions for over 15 years. Leveraging our unmatched network of 68 offices worldwide, Baker & McKenzie’s Global Equity Services (GES) attorneys
provide state-of-the art design, implementation and tax/legal compliance advice for over 300 companies
worldwide with equity and benefit plans operating in 130+ countries. Our cutting edge approach integrates
tax and legal solutions in all jurisdictions fluently and contemporaneously, with centralized and integrated
project management. With unparalleled depth and experience, we provide the most cost effective solutions
to our clients.
www.bakermckenzie.com/ges
Deloitte Tax LLP
Established more than 35 years ago, Deloitte’s Global Employer Services practice is a strategic focus area
for our organization. Within GES, one of our main competencies is Global Rewards. The Global Rewards
practice is the largest in the world with 300 practitioners in 50 countries. We serve more than 200 of the
world’s leading multinationals.
Ernst & Young LLP
Performance & Reward Practice: We know your top talent is a precious resource. Our 500-plus global Human Capital - Performance and Reward professionals can help you create “leading practice” HR, compensation and benefit programs that are in tune with your corporate strategy. We can help you design compensation programs and equity incentives that really engage your top people. We can help evaluate and
identify process improvement opportunities that assist you in improving the HR function’s performance and
service delivery while reducing compliance risks. With equity incentives, our Performance & Reward professionals can assist globally with the design, tax, accounting, and administrative aspects of your programs,
including technology and the use of third party administrators and help you coordinate your programs with
the tax, accounting, legal and payroll functions within your organization. We help you administer your programs globally more effectively. It’s how Ernst & Young makes a difference.
www.ey.com/US/en/Services/Tax/Human-Capital/Performance-and-Reward
Equity Methods
Equity Methods serves over 25% of the Fortune 100 and more than 400 companies through its secondto-none expertise and technology rich-solutions for equity compensation valuation, accounting and award
design. Equity Methods leverages its suite of platforms to address both US GAAP (FAS 123R / ASC 718)
and IFRS 2 reporting requirements. Our unique capability to provide answers to unconventional or complex situations has given our clients the confidence they need to meet their equity compensation reporting
responsibilities. We help clients mitigate risk and eliminate manual processes via comprehensive capabilities
that span data analysis, valuation science, technical accounting, controls design, and audit support. Our
technology-driven solutions support all facets of equity compensation accounting.
www.equitymethods.com
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| About our sponsors
Our Global Rewards specialists have deep experience in global equity, corporate tax, expatriate tax, executive compensation, employee benefits, payroll, regulatory matters, technology, and employee communications to address the myriad of tax, regulatory, and administrative issues that arise with sponsorship of global
rewards programs. We believe an integrated offering is the only way to address the often intertwined, and
sometimes competing, concerns of key stakeholders that arise when extending compensation programs
across borders.
www.deloitte.com
ABOUT
THE CERTIFIED EQUITY PROFESSIONAL INSTITUTE
The Certified Equity Professional Institute (CEPI) at Santa Clara University is the
only source of professional certification for equity compensation professionals.
The CEPI is a nonprofit, academic organization with a mission of establishing,
promoting, and providing certification and continuing education for the equity
compensation industry.
Since its founding in 1989, the CEP Institute self-study curriculum has served as the
industry’s educational standard. Organizations and individuals use Institute exams as a
measurement of basic (Level I), intermediate (Level II), and advanced (Level III) knowledge,
skills, and abilities related to equity compensation administration. The CEPI curriculum
covers accounting, corporate and securities laws, taxation, and equity plan design, analysis,
and administration, ensuring that CEP designees have achieved a required level of expertise
in all of the relevant areas of equity compensation.
As the only source of professional certification in equity compensation, the CEPI recognizes
and understands the critical need for impartial guidance in this area. The CEPI has
undertaken a series of research projects entitled GPS: Guidance Procedures Systems.
Previous GPS include:
• GPS | Performance Awards
• GPS | Global Stock Plans
• GPS | Restricted Stock and Restricted Stock Units
• GPS | Non-Qualified Stock Options
Previous GPS publications can be accessed at www.scu.edu/business/cepi/.
This research project of the CEPI is supported by title sponsors Bank of America Merrill
Lynch, Computershare, E*TRADE Corporate Services, Fidelity Stock Plan Services, and
Morgan Stanley Smith Barney; by in kind sponsor Radford; and by contributing sponsors
Baker & McKenzie LLP, Deloitte LLP, Ernst & Young LLP, and Equity Methods.
Information in this publication should not be used as a substitute for legal, accounting, tax,
or other professional advice. Please consult your own professional advisors with respect to
the application of the information in this publication to company specific circumstances.
www.scu.edu/business/cepi
© Santa Clara University, Certified Equity Professional Institute, 2011 and 2015
Contributing sponsors: